I.

2009 REPRESENTATION UPDATE

by

ROBERT E. McKENZIE, EA, ATTORNEY

©2009

ARNSTEIN & LEHR

SUITE 1200
120 SOUTH RIVERSIDE PLAZA
Chicago, Illinois 60606
(312) 876-7100
REMCKENZIE@ARNSTEIN.COM
http://www.mckenzielaw.com/
 2009 IRS REPRESENTATION UPDATE©
By: Robert E. McKenzie

1. A CHANGING IRS........................................................................................................1
More Compliance Centers to Cease Processing Returns:............................................1
Shrinking IRS Workforce................................................................................................1
New IRS Commissioner ................................................................................................2
2. TAXPAYER ADVOCATE..............................................................................................2
National Taxpayer Advocate Releases Report To Congress........................................2
The Most Litigated Tax Issues.....................................................................................11
3. ENFORCEMENT........................................................................................................13
Highlights of 2008 Enforcement...................................................................................13
Individual Enforcement.................................................................................................13
Millionaires...................................................................................................................13
Businesses...................................................................................................................14
Collection Enforcement................................................................................................14
Electronic Filing IRS Webpage....................................................................................14
State Information Sharing............................................................................................19
Federal Tax Returns and Return Information..............................................................19
Return Information........................................................................................................19
IRS Study Provides Tax Gap Estimate........................................................................20
Sources of Misreporting...............................................................................................20
Understanding the Tax Gap.........................................................................................20
Components of the Tax Gap........................................................................................20
Underreporting.............................................................................................................20
Underreporting Is Largest Component.........................................................................21
Noncompliance Rising.................................................................................................21
Areas Where Compliance Has Decreased..................................................................21
Areas With Improved Compliance...............................................................................22
Businesses More Likely to Not Comply.......................................................................22
NRP Subchapter S Corporation Study Overview........................................................22
2009 Budget.................................................................................................................26
2009 Budget ................................................................................................................26
Overview - Abusive Return Preparer...........................................................................27
Audits of 30 Clients......................................................................................................28
4. EXAMINATION...........................................................................................................29
Examination Reengineering.........................................................................................29
The Dirty Dozen...........................................................................................................29
5. APPEALS....................................................................................................................32
Strategic Priorities:.......................................................................................................32
Campus Appeals Program...........................................................................................32
OIC and TFRP Mediation and Arbitration....................................................................32
Application Process .....................................................................................................33
TFRP............................................................................................................................33

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6. USEFUL INFORMATION FOR PRACTITIONERS....................................................34
Whistleblower Reforms................................................................................................34
Mortgage Relief Act......................................................................................................34
Basis Reduction...........................................................................................................35
Qualified Principal Residence Indebtedness...............................................................35
Misclassified Workers..................................................................................................35
Misclassification...........................................................................................................35
Recommendations.......................................................................................................36
UBS Criminal Charges.................................................................................................36
Agreement....................................................................................................................36
Allegations....................................................................................................................36
Prior Charges...............................................................................................................37
Comments of Government Officials.............................................................................37
Settlement Offer Unreported Offshore Income ...........................................................37
Highlights of the Offer. ................................................................................................37
Penalties.......................................................................................................................38
Fully Cooperate............................................................................................................38
VITA Grant Program....................................................................................................38
Identity Theft.................................................................................................................39
7. COLLECTION.............................................................................................................42
Taxpayer Advocate’s Report On Enforced Collection ................................................42
Flawed Private Collection Ends...................................................................................42
Help for People Who Owe Taxes.................................................................................43
Flexibility.......................................................................................................................43
Online Payment Agreement (OPA) .............................................................................44
Guaranteed Availability of Installment Agreements....................................................45
<$25,000 Liabilities......................................................................................................45
Form 433A....................................................................................................................45
New more Onerous Allowable Expense Standards.....................................................45
Five Year Test..............................................................................................................48
8. OFFER IN COMPROMISE.........................................................................................48
Number of Offers..........................................................................................................48
OIC’s FY2000 to 2008..................................................................................................49
Tax Increase Prevention and Reconciliation Act of 2005............................................49
Payments With Offers..................................................................................................49
Failure to Make Deposit...............................................................................................49
Not Refundable............................................................................................................50
Taxpayer Advocate Research......................................................................................50
Failure to Make Installment Payments.........................................................................50
Low Income Taxpayers................................................................................................50
Deemed Accepted........................................................................................................51
Background..................................................................................................................51
Supporting Documents.................................................................................................51
$150 Processing Fee...................................................................................................51
Determining Processability...........................................................................................52
Full Pay Processing......................................................................................................53

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Initial Review................................................................................................................53
Computation of Offer Amount......................................................................................53
Cash Offer....................................................................................................................54
Short-Term Deferred Payment Offer............................................................................54
Deferred Payment Offers.............................................................................................54
Corporate Trust Fund Liabilities...................................................................................55
Pursuit of Officers After Compromise..........................................................................55
Promote Effective Tax Administration..........................................................................55
Encourage Compliance................................................................................................55
Only Available If There Is No Doubt As to Liability Or Collectibility.............................56
Rules for Evaluating Offers to Promote Effective Tax Administration.........................56
Factors..........................................................................................................................56
Undermine Compliance................................................................................................56
Exceptional Circumstances..........................................................................................56
California......................................................................................................................68
.....................................................................................................................................68

EXHIBITS 59-70

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 2009 IRS REPRESENTATION UPDATE©
By: Robert E. McKenzie

1. A CHANGING IRS

More Compliance Centers to Cease Processing Returns:

1.10 Because of electronic filing the IRS is gradually eliminating its return processing
centers. The closure schedule is as follows.

• Philadelphia, Memphis & Holtsville no longer process

• Andover 10-09
• Atlanta 10-11

As of October, 2011 there will be 2 returns processing centers for business returns and
3 returns processing centers for individual returns. Each of the remaining compliance
centers will continue performing correspondence audits and collection activities.

Shrinking IRS Workforce

1.15 As a result of Congressional cuts in IRS budgets its workforce continued to
shrink in 2008. It’s workforce has shrunk from about 100,000 in 2002 to about 90,000 in
2008.

Table 30. Internal Revenue Service Personnel Summary and Type of Personnel, Fiscal Years
2007 and 2008

Employment status, budget activity, Average positions realized Number of employees

and selected personnel type [1] at close of fiscal year

2007 2008 2007 2008

(1) (2) (3) (4)

Internal Revenue Service, total [r] 92,017 90,647 86,638 90,210

Selected personnel type:
Customer Service Representatives [r] 18,681 17,736 19,307 18,316
Revenue Agents [r] 12,816 12,587 13,026 12,951
Seasonal employees [r] 9,861 10,025 4,525 8,422
Revenue Officers [r] 5,663 5,493 5,468 5,481
Tax Technicians [r] 3,110 1,496 1,506 1,538
Special Agents [r] 2,677 2,590 2,683 2,617
Attorneys [r] 1,415 1,397 1,455 1,429
Appeals Officers [r] 775 768 798 781

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New IRS Commissioner
1.20 In March, 2008 the Senate unanimously confirmed IRS Commissioner Douglas
H. Shulman. He promised would work to ensure that the tax agency is fair, and he
would concentrate both on enforcement and service. "For the majority of Americans
who pay their taxes willingly and on time, there must be clear guidance, accessible
education and outstanding service," he said in a statement. "For taxpayers who
intentionally evade paying taxes, there must be rigorous enforcement programs."
Shulman has been vice chairman of the Financial Industry Regulatory Authority,
previously known as the National Association of Securities Dealers. He also has served
on the bipartisan National Commission on Restructuring the Internal Revenue Service.

2. TAXPAYER ADVOCATE

National Taxpayer Advocate Releases Report To Congress

2.10 In January 2009 National Taxpayer Advocate Nina E. Olson released a report to
Congress. Internal Revenue Code (IRC) § 7803(c)(2)(B)(ii)(III) requires the National
Taxpayer Advocate to describe at least 20 of the most serious problems encountered by
taxpayers. Each of the most serious problems includes the National Taxpayer
Advocate’s description of the problem, the IRS’s response, and the National Taxpayer
Advocate’s final comments and recommendations. This format provides a clear picture
of which steps have been taken to address the most serious problems and which
additional steps the National Taxpayer Advocate believes are required. The problems
described in the report are as follows:

1. Complexity of the Tax Code. The largest source of compliance burdens for
taxpayers is the complexity of the tax code. IRS data show that taxpayers and
businesses spend 7.6 billion hours a year complying with tax-filing requirements.
To place this in context, it would require 3.8 million full-time employees to work
7.6 billion hours. In dollar terms, we estimate that taxpayers spend $193 billion a
year complying with income tax requirements, which amounts to 14 percent of
aggregate income tax receipts. One count shows the number of words in the tax
code has reached 3.7 million, and over the past eight years, changes to the tax
code have been made at a rate of more than one a day – including more than
500 changes in 2008 alone. All of this complexity imposes additional monetary
costs on taxpayers – about 60 percent of individual taxpayers pay practitioners to
prepare their returns and an additional 22 percent purchase tax software to assist
them. Perhaps most troubling, tax law complexity leads to perverse results. On
the one hand, taxpayers who honestly seek to comply with the law often make
inadvertent errors, causing them either to overpay their tax or to become subject
to IRS enforcement action for mistaken underpayments of tax. On the other
hand, sophisticated taxpayers often find loopholes that enable them to reduce or
eliminate their tax liabilities. The NTA recommends that Congress substantially
simplify the tax code. To assist Congress in pursuing tax simplification, this report
includes a series of recommendations, including recommendations to repeal the
Alternative Minimum Tax, streamline education and retirement savings tax
incentives, simplify the family status provisions of the Code, allow taxpayers to
exclude modest amounts of canceled debts from income without having to make

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an affirmative claim, reduce tax sunset and phaseout provisions, and revise the
overall penalty structure..

2. The IRS Needs to More Fully Consider the Impact of Collection

Enforcement Actions on Taxpayers Experiencing Economic Difficulties.
When the IRS contemplates taking enforced collection action against a taxpayer,
both the tax code and IRS procedures require that IRS personnel consider
whether the collection action will impose an economic hardship on the taxpayer.
When the economy struggles and more taxpayers become unable to pay their
tax liabilities, the importance of considering the impact of collection actions on
taxpayers and their families becomes critical. In addition, while levy and seizure
authority are important collection tools that allow the IRS to address serious
incidents of noncompliance, a review of IRS historical enforcement data suggests
that expanded use – as opposed to judicious use – of these tools does not
necessarily translate into more tax dollars collected. For example, while the
number of levies issued by the IRS increased by an astonishing 1,608 percent
from fiscal year (FY) 2000 to FY 2007 – from 220,000 levies to about 3.76 million
– the increase in total collection yield during this period was slightly less than 45
percent. To the contrary, historical enforcement data indicate that collection
alternatives may be more effective at collecting liabilities from taxpayers having
trouble paying their tax debts. To more effectively deal with taxpayers in these
difficult economic times, the NTA recommends that the IRS provide specific
guidance requiring pre-decisional consideration of economic hardship in all
Internal Revenue Manual sections related to collection enforcement and
encourage greater use of collection payment alternatives such as offers in
compromise and partial payment installment agreements where economic
hardship is present.

3. Understanding and Reporting the Tax Consequences of Cancellation of

Debt Income. When a creditor writes off a debt, the tax code generally treats the
amount of the canceled debt as taxable income to the debtor, but Congress has
carved out a number of exceptions. The rules that determine whether
cancellation of debt income is includible in gross income are complex, and
taxpayers often do not receive reliable information about their tax reporting and
payment obligations. For example, the Mortgage Forgiveness Debt Relief Act of
2007 carved out an exception for debts canceled in the course of a home
foreclosure, but the exception only applies to the extent that the loan proceeds
were used to acquire or improve a principal residence. It appears that most
subprime borrowers use a portion of their loans for other purposes (e.g., to pay
off car loans, credit card balances, student loans, or medical bills), and the
exception does not apply to the extent loan proceeds were used for these “non-
qualified” purposes. Moreover, taxpayers do not automatically receive the benefit
of any exception. If they do not file Form 982, Reduction of Tax Attributes Due to
Discharge of Indebtedness (and Section 1082 Basis Adjustment), with their tax
returns to claim an exclusion and adjust their tax attributes, the IRS will assume
the cancellation of debt is taxable (based on its receipt of a Form 1099-C,
Cancellation of Debt, filed by the creditor). Even where Form 982 is properly
filed, taxpayers who exclude canceled debt from income under the “insolvency”
exception may receive IRS notices requesting additional documentation if they
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do not also provide a statement of insolvency, a requirement that does not
appear in any IRS forms or publications. The NTA recommends that the IRS take
several steps to address this problem, including developing an insolvency
worksheet that taxpayers can file with their returns and creating a centralized unit
dedicated to handling cancellation of debt issues.

4. Employment Taxes. The NTA is concerned that IRS employment tax policies
may overreach and undermine some of the important protections enacted in the
Taxpayer Bill of Rights and the IRS Restructuring and Reform Act of 1998. With
an estimated $58 billion in unpaid employment taxes, it is clear that the IRS faces
a significant noncompliance problem. At the same time, the overall employment
tax compliance rate is high – approximately 88 percent of all employment tax
returns are filed and fully paid. While the need to collect unpaid payroll taxes is
obvious, the IRS should follow a tailored approach to address the problem,
including applying different treatments to taxpayers based on their levels of and
reasons for noncompliance, encouraging prospective voluntary compliance by
helping taxpayers who are attempting to follow complex rules and procedures,
concentrating sufficient resources on early intervention techniques to prevent the
accumulation of substantial employment tax liabilities, and building a local
compliance presence that balances enforcement with outreach and education.

5. IRS Process Improvements to Assist Victims of Identity Theft. Identity

theft occurs when one person unlawfully uses another person’s personal data to
commit fraud or other crimes. In the past year, the IRS has improved its identity
theft process in a number of ways, including establishing an Identity Protection
Specialized Unit and a toll-free hotline for identity theft victims. These changes, if
properly managed, should provide more assistance to victims of identity theft.
The IRS recognizes identity theft as a serious problem and has agreed to
address the concerns and recommendations that the NTA has previously raised.
In light of the IRS’s agreement with our suggestions, the NTA makes no specific
additional recommendations at this time. However, she will continue to urge the
IRS to implement the following actions: provide global account review and
account monitoring (if necessary) for all identity theft victims; allow employees
the discretion to deviate from established guidelines in accepting evidence of
identity theft; and allow employees more latitude in determining the rightful owner
of a disputed Social Security number.

Taxpayer Service Issues

6. Taxpayer Service: Bringing Service to the Taxpayer. Since announcing its

original plan in 2001 to establish 676 Taxpayer Assistance Center (TAC) sites,
the IRS has established only 401 TACs and just 55 percent of them are open 36
to 40 hours per week. Further, 40 percent of taxpayers live more than a 30-
minute drive from a TAC, and TACs are unable to handle many issues and
questions. Similarly, the Small Business/Self-Employed Division since 2001 has
sharply reduced its planned education and outreach program for small business
taxpayers. In both instances, the IRS has sought to meet taxpayer needs by
increasing Internet service. While that trend is generally positive, there remain
significant numbers of taxpayers who do not have access to the Internet and
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there are certain categories of service that are more effectively handled through
face-to-face interaction. The NTA recommends that the IRS collaborate with TAS
on all ongoing and new studies pertaining to taxpayer service, including the
Taxpayer Assistance Blueprint for small business and self-employed taxpayers
currently underway, and take steps to identify innovative approaches to
delivering in-person assistance.

7. Navigating the IRS. The IRS employs more than 100,000 workers in 12 major
business units in over 800 offices within and outside the United States.
Taxpayers, practitioners, and even IRS employees have difficulty finding the
appropriate office or employee to help them resolve tax problems. The IRS does
not publish a topical or personnel directory that would assist taxpayers in
navigating the agency. By comparison, this information is provided clearly on the
websites of taxing authorities in other countries and U.S. states. The NTA
recommends that the IRS take steps to address this problem, including revising
the Internal Revenue Manual to direct IRS employees to accommodate taxpayer
requests to speak to a particular employee, adding departmental phone numbers
to the topical index on IRS.gov, and considering the creation of a phone number
staffed by operators who would obtain details about the taxpayer’s question or
problem and direct the taxpayer to the function that can help.

8. IRS Handling of ITIN Applications Significantly Delays Taxpayer Returns

and Refunds. Any individual who must file a tax return but is not eligible to
obtain a Social Security number must apply to the IRS for an Individual Taxpayer
Identification Number (ITIN). With limited exceptions, ITIN applications must be
submitted with a tax return filed on paper. In 2005, the inability to receive an ITIN
before preparing and filing a paper tax return caused processing delays that
affected 280,000 refunds totaling over $500 million. In addition, the IRS
requirement for ITIN applicants to file paper returns is inconsistent with the
congressional mandate for the IRS to achieve an 80 percent e-file rate. The IRS
has provided inadequate assistance and information to applicants, as evidenced
by the high number of Incomplete and rejected applications, restricted telephone
access to ITIN personnel, and failure to expand the Certified Acceptance Agent
program. The NTA recommends several actions for streamlining the ITIN
process, which include permitting individuals to submit an ITIN application prior
to the filing season where the individuals can demonstrate an imminent need to
file a return, allowing new ITIN applicants to file returns electronically, and
promptly acknowledging all applicant requests for the return of original
documents.

9. Access to the IRS by Individual Taxpayers Located Outside the United

States. Approximately five million American citizens living outside the country
and over a half million troops deployed overseas need a way to contact the IRS
when they have inquiries about their accounts or the tax laws. These taxpayers
have limited options for obtaining information, filing returns, and replying to IRS
notices and letters. There are only four IRS overseas customer service posts
available to taxpayers with U.S. filing obligations, who are spread over 194
countries and more than 60 territories. Those outside the United States generally
incur greater expenses, such as international telephone charges, transportation,
5
and carrier mailing costs, when trying to communicate with the IRS. Although the
IRS has developed customer service initiatives as a part of its strategy for
international tax administration, it does not provide enough resources to meet the
needs and preferences of taxpayers based outside the country. The NTA’s
recommendations for improving customer service for overseas taxpayers include
opening toll-free international telephone lines and providing overseas taxpayers
with secure online access to their tax accounts.

Compliance Issues

10. Customer Service Within Compliance. Simply stated, the IRS gets what it
measures. The IRS largely rates operational performance by using efficiency
measures (e.g., cycle time, case closures, and average call time) instead of
effectiveness measures (e.g., did the IRS’s actions achieve the desired voluntary
compliance results?). The 2008-2009 IRS Strategic Initiative includes the goal to
“Improve service to make voluntary compliance easier.” Yet current measures do
not promote customer service and may ultimately lead to noncompliant behavior
by taxpayers, because IRS business strategies and measures do not adequately
emphasize a balanced approach between taxpayer service and enforcement
within the IRS’s compliance organizations. The IRS has the opportunity to
establish taxpayer-centric measures that encompass effectiveness as well as
efficiency components to accomplish this strategic goal. The NTA recommends
four actions to address this problem, including creating an IRS Cognitive
Learning Lab and making it possible for taxpayers to work with one employee
from start to finish on a case.

11. Local Compliance Initiatives Have Great Potential But Face Significant
Challenges. Research suggests that concentrated examinations targeted at a
local business segment or industry have a greater “ripple effect” on voluntary
compliance by other taxpayers than seemingly random examinations.
Compliance initiative projects (CIPs) allow local IRS employees to generate this
impact by focusing on specific local compliance problems using examinations or
“alternative treatments,” which may include outreach, education, form changes,
regulatory changes, or even agreements with the states. The CIP process also
enables employees from different IRS functions to work together, utilize local
sources of information, and reach out to local organizations to address
noncompliance at the local level. In addition, CIPs allow the IRS to learn about
what works and what does not. The NTA is concerned that the IRS has
neglected this important program. She recommends that the IRS take steps to
revitalize it, such as developing better measures for local CIPs, allocating more
resources to local CIPs, and making CIP reports more widely available to
preserve the benefits of any lessons learned.

12. Customer Service Issues in the IRS’s Automated Collection System

(ACS). ACS is a main component of the IRS’s collection process, sending
automated collection notices to millions of taxpayers and employing numerous
telephone assistors to receive calls from these taxpayers. Although ACS
generally receives relatively high customer satisfaction survey ratings and
internal quality assessments, TAS has received numerous complaints from tax
6
professionals and taxpayers that suggest the need for improvements. ACS
customers have raised concerns about extensive wait times, the inability to fax
documents to employees, overly burdensome procedures, and general
dissatisfaction with the ACS process. Neither ACS’s customer satisfaction
surveys nor its internal quality reviews measure these important aspects of
taxpayer service. The NTA has identified several steps the IRS can take to
improve processes that drive customer satisfaction, most importantly the need for
the IRS to evaluate the entire customer experience with ACS instead of
assessing only a “snapshot” in time.

13. The IRS Should Proactively Address Emerging Issues Such as Those
Arising From “Virtual Worlds.” By one estimate, about $1 billion in real dollars
changed hands in computer-based environments called “virtual worlds” in 2005.
Over 16 million people are estimated to have active subscriptions to these
environments, many of which have their own virtual economies and currencies.
However, IRS employees have been unable to respond to taxpayer inquiries
about how to report transactions associated with them. Economic activities in
virtual worlds may present an emerging area of tax noncompliance, in part
because the IRS has not provided guidance about whether and how taxpayers
should report such activities. To improve voluntary tax compliance, the NTA
recommends that the IRS issue guidance addressing how taxpayers should
report economic activities in virtual worlds.

Examination Issues

14. Suitability of the Examination Process. Since 2000, the IRS has
continuously increased the number of individual income tax return examinations
it conducts. The number more than doubled from 617,765 in FY 2000 to
1,384,563 in FY 2007, with examinations completed by correspondence
accounting for 83 percent of all individual taxpayer audits. Although taxpayers
understandably do not like to be audited, the IRS should initially assume good
faith on the part of taxpayers and avoid taking an unnecessarily adversarial
approach. The Internal Revenue Manual and IRS publications provide
opportunities for the IRS to meet taxpayer needs and preferences throughout the
examination process, including allowing taxpayers to choose a method for
conducting an examination (face-to-face versus correspondence), request a
telephone discussion with the examiner, and even set up a payment agreement
for any taxes owed. Because the IRS often fails to meet taxpayer needs and
preferences due to limited resources or policy reasons, the resulting unsuitability
of the examination process can lead to disparities in audit and customer
satisfaction results, including tax assessments that sometimes reflect the
taxpayer’s inability to navigate the audit process rather than the amount truly
owed. The NTA recommends five actions to help the IRS address problems with
the suitability of the examination process, including directing its focus
substantially toward meeting taxpayer needs and preferences and immediately
eliminating the so-called “combination letter” from the process.

15. The IRS Correspondence Examination Program Promotes Premature

Notices, Case Closures, and Assessments. In FY 2007, the IRS conducted 83
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percent of all individual income tax examinations exclusively by mail in an effort
to expand its audit coverage. The program as currently designed, however, is
plagued by problems that increase taxpayer burden. These problems include a
preoccupation with closing cases rather than working with taxpayers to resolve
audit issues and an automated process that causes perpetual delays in
responding to taxpayer correspondence. These issues lead to premature notices,
premature case closures, and premature assessments, all of which drive
taxpayers to TAS for help and generate needless re-work for IRS employees.
The NTA urges the IRS to protect taxpayers by requiring managers and
employees to adhere to the agency’s longstanding audit quality standards in
conducting correspondence examinations.

Tax Administration Issues

16. The Impact of IRS Centralization on Tax Administration. Over the years,
the IRS has centralized many of its major operations and programs. This
centralization has significantly changed the organizational structure,
management, work processes, and the quality of interaction between the IRS
and taxpayers. When carried out correctly, centralization can significantly reduce
redundancies and increase effectiveness. However, if the IRS fails to consider
the impact of centralization on taxpayer service and compliance, it may harm
taxpayers. The IRS needs to do a better job of measuring the downstream
consequences to taxpayers, including the impact on taxpayer service and
compliance, when evaluating the costs and benefits of centralization. The NTA
recommends that the IRS establish a standard matrix that defines the project,
provides background information, sets forth objectives, establishes tangible
products, quantifies expected benefits, and identifies necessary resources. The
IRS should then use this standard project matrix to evaluate programs and
determine whether the anticipated benefits of centralization have been realized.

17. Incorrect Examination Referrals and Prioritization Decisions Cause

Substantial Delays in Amended Return Processing for Individuals. Every
year, more than three million taxpayers file amended returns for various reasons,
including the complexity of the tax code, changes in their circumstances, late-
year tax legislation, and incomplete or inaccurate tax preparation software. Many
of these taxpayers experience unnecessary burden and delays. A cooperative
IRS-TAS study of TAS amended return cases found the average taxpayer waited
26 weeks for the amended return to be processed before contacting TAS for
assistance. These delays stem from the IRS not meeting its own processing
guidelines, unnecessary referrals for audits, and management decisions to de-
emphasize processing so-called “duplicate filings,” which occur when more than
one Form 1040 is filed with the same name and Social Security number. The
NTA recommends that the IRS allow individual taxpayers to file amended returns
electronically to reduce errors and shorten processing times, eliminate
unnecessary audit referrals, and create a special unit to resolve duplicate filing
cases as a top priority.

18. Inadequate Files Management Burdens Taxpayers. From FY 2005

through FY 2008, the IRS refunded over 40 percent (more than $3.7 million) of
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the fees it collected for photocopies of taxpayers’ documents because it could not
locate the files the taxpayers needed. The IRS is required by law to efficiently
maintain and manage agency records, including electronic and paper files, as
evidence of IRS policies, decisions, and operations. Both taxpayers and IRS
employees need prompt access to paper documents to resolve tax return issues
or verify taxpayer information, yet the IRS has failed to follow procedures and
implement safeguards for maintaining and managing paper files and records.
This failure has contributed to complaints from taxpayers, practitioners, IRS
employees, and other stakeholders who experienced substantial delays or
received the wrong taxpayer’s documents. Although control of the Files operation
reverted back to the IRS in 2008 after being contracted out for the past two
years, the transition has not resolved most of the associated problems. To further
improve the Files operation, the NTA recommends the IRS take proactive steps
to develop a service-wide recordkeeping and paper-file management strategy
and database, take steps to convert paper returns to an electronic format, and
revise relevant Internal Revenue Manual provisions to employ adequate quality
control and specific timeliness measurements for expedited taxpayer files
requests.

19. The IRS Miscalculates Interest and Penalties But Fails to Correct These
Errors Due to Restrictive Abatement Policies. A TAS study has found that the
IRS is miscalculating the failure to pay penalty and could be negatively impacting
about two million taxpayer accounts annually. Moreover, the IRS’s manual
calculations of interest yields an accuracy rate of only 67.7 percent, which means
nearly one out of three restricted interest accounts are incorrectly computed. The
IRS is aware of, but has failed to correct, certain systemic problems that cause
penalty and interest miscalculations. These incorrect calculations lead numerous
taxpayers to believe they have fully paid what the IRS says they owe, only to
receive subsequent bills for accruals of interest, penalties, or both. The IRS
bears the cost of these inaccurate calculations, not only through rework by
employees but also by taxpayers’ reduced confidence in the IRS. The NTA
recommends that the IRS consider allocating adequate resources toward
planning and programming to resolve common penalty and interest computation
issues, revising pertinent Internal Revenue Manual sections so all taxpayers are
entitled to accuracy reviews of interest and penalty calculations, and re-
evaluating the overly complex restricted interest procedures to make certain that
all taxpayers receive accurate interest charges.

20. Inefficiencies in the Administration of the Combined Annual Wage

Reporting Program Impose Substantial Burden on Employers and Waste
IRS Resources. The Combined Annual Wage Reporting (CAWR) program is
designed to ensure that employers accurately report annual wage data to the IRS
and the Social Security Administration. If the IRS discovers a discrepancy in the
wage and tax data reported by an employer, it issues a notice and requests that
the employer provide information to resolve the discrepancy. However, the
CAWR notices are not clearly written. As a result, employers are often unable to
identify the cause of the discrepancy and respond timely, which in turn may lead
the IRS to improperly impose penalties on the employers. From FY 2003 to FY
2008, the IRS eventually abated 81 percent of the penalty dollars it previously
9
assessed, causing substantial rework for the IRS and needlessly burdening
employers. The NTA recommends that the IRS provide specific information about
the wage reporting discrepancy on notices, include the phone number for a live
assistor in the CAWR unit on notices, and continuously train its employees about
when it is appropriate to assess CAWR penalties.

Status Update

The IRS’s Private Debt Collection (PDC) Initiative I 21. s Failing In Most
Respects. IRS data now shows that the IRS’s Collection function outperforms
private collection agencies (PCAs) in almost every way, collecting three times as
much as the PCAs and resolving more cases earlier in the process. Overall, the
PCAs have only collected about four percent of the outstanding tax balances
assigned to them, bringing in less than $56 million in commissionable payments
on $1.46 billion of tax debt. The NTA has addressed a number of the PDC
initiative’s deficiencies in prior Annual Reports to Congress and testimony. Many
of these concerns remain while new ones have arisen. In addition, despite initial
expectations that the IRS could learn about state-of-the-art collection practices in
private industry through its work with PCAs, the IRS has now acknowledged that
it has not been able to identify any “best practices” from the private debt
collection industry. The NTA remains concerned that there is an inherently
greater risk to taxpayer compliance, taxpayer rights, and taxpayer privacy when
tax collection is outsourced to private, for-profit businesses. Given this risk and
the PCAs’ unambiguous underperformance as compared with the IRS’s own
Collection function, the NTA continues to believe that the PDC program should
be terminated.

10
The Most Litigated Tax Issues
2.20 IRC§7803(c)(2)(B)(ii)(X) requires the National Taxpayer Advocate to identify the
ten tax issues most often litigated in the federal courts and to classify those issues by
the category of taxpayer affected. The following is a table the most litigated as
determined by TAS:

1
Gross Income 68 8 12% 137 7%
0
1
Collection Due Process 104 8 8% 75 13%
0
Summons Enforcement 108 1 1% 38 8 21%
2 1
Trade or Business Expense 78 27% 38 26%
1 0
1
Accuracy-Related Penalty 47 8 17% 40 43%
7
Civil Damages for Certain Unauthorized Collection 60 8 13% 18 1 6%

Failure to File and Estimated Tax Penalties 47 5 11% 19 3 16%

Joint and Several Liability 27 5 19% 23 7 30%

Frivolous Issues Penalty (and analo-gous appellate- 45 8 18% 4 1 25%
level sanctions)
Family Status Issues 33 2 6% 1 0 0%
7 6
Totals 617 12% 393 17%
4 7

11
Table 20. Taxpayer Advocate Service: Postfiling Taxpayer Assistance Program, by
Type
of Issue and Relief, Fiscal Year 2008

Type of issue and relief Number

Percentage of total

Applications for taxpayer assistance received, by type of issue [1]:

Total 274,051 100
Processing amended returns 21,963 8
Levies 17,082 6
Other refund inquiries/issues 14,817 5
Injured spouse claims 14,238 5
Earned income tax credit 13,489 5
Automated Substitute for Return Program [2] 12,419 5
Expedite refund requests 11,376 4
Criminal investigation 10,152 4
Processing original returns 10,021 4
Automated Underreporter Program [3] 9,594 4
All others 138,900 51
Applications for taxpayer assistance closed, by type of resolution [1]:
Total 260,439 100

Relief provided to taxpayer, total 189,046 73

Taxpayer Assistance Order issued [4,5] 50 [6]

No Taxpayer Assistance Order issued [4] 188,996 73
Full relief 176,209 68
Individual taxpayer issue [7] 158,198 61
Systemic issue [8] 18,011 7
Partial relief 12,787 5
Individual taxpayer issue [7] 11,643 4
Systemic issue [8] 1,144 [6]
No relief provided to taxpayer, total 71,393 27

Taxpayer Assistance Order rescinded [4,5] 8 [6]

No Taxpayer Assistance Order issued [4] 71,385 27
No response from taxpayer 35,401 14
Relief provided prior to Taxpayer Advocate Service intervention 14,526 6
Taxpayer withdrew application for assistance 3,530 1
Tax law precluded relief 1,913 1
Hardship not related to revenue laws 1,276 [6]
Hardship not validated 845 [6]
All others 13,894 5
Congressional inquiries [9] 22,097 N/A

12
3. ENFORCEMENT

Highlights of 2008 Enforcement

3.10 The IRS continues increase its enforcement activities. he IRS enforcement
efforts increased again in fiscal year 2007. For instance, during 2007 the IRS audited 84
percent more returns of individuals with incomes of $1 million or more than during 2006.
Overall, enforcement revenue reached $59.2 billion, up from $48.7 billion in 2006 and
nearly $34.1 billion in 2002. IRS collected $56.4 billion in enforcement revenue in 2008,
down $2.8 million from 2007, Stiff said. She said 2007 was a record-breaking year for
enforcement and saw some anomalies that did not repeat themselves in 2008, such as
a few large corporate closures and cases closed out during tax shelter inventories. Audit
enforcement revenue decreased from $23.8 billion to $20.6 billion; and Collection
enforcement revenue decreased slightly from $31.8 billion to $31.1 billion

Individual Enforcement
3.20 The number of audits of individual returns increased slightly in 2008. Those who
earned less than $200,000 had about a 1 percent chance of being audited. Those with
incomes of $200,000 and more had about a 3 percent chance of being audited.

Millionaires
3.30 Meanwhile, taxpayers with incomes of more than $1 million had a 5.6 percent
chance of being audited, a drop from 6.8 percent the year before. The number of audits
for millionaires dropped even though their ranks increased by nearly 54,000.

“We essentially audited as many millionaires as in the previous year, but there were
more returns,” said Terry Lemons, an I.R.S. spokesman. The I.R.S. said it audited just
over 23,000 returns of the nearly 340,000 filed by millionaires in 2007. That compares
with just over 21,800 returns filed by 398,000 millionaires in 2008.

13
The income of the 400 wealthiest Americans swelled in 2006, to an average of $263
million, according to I.R.S. data. Since 1996, this group’s share of the nation’s total
wealth has nearly doubled to more than 22 percent.

Businesses
3.40 On the business front, the overall number of audits rose slightly, but dropped as
a percentage of businesses that submitted a tax return. More emphasis was placed on
medium and large corporations, as audit rates increased slightly for those companies
with more than $50 million in assets and dropped slightly for those with less than $50
million in assets. According to 2008 IRS enforcement data released by the IRS audited
15.3% of returns of corporations with assets of $10 million or more. That is the lowest
audit coverage level since 2003 and down from a 20% coverage rate in 2005.

The tax audit rates of the largest companies are less than half what they were 20 years
ago while more small and mid-size businesses are coming under scrutiny, according to
an organization that monitors the Internal Revenue Service. The Syracuse University-
based Transactional Records Access Clearinghouse has described a "historic collapse"
in audits for corporations holding assets of $250 million or more. About 26 percent of
them were audited in the 2007 budget year compared with 34 percent in 2006 and 43
percent in 2005.

Collection Enforcement
3.50 Overall, some of our most common enforcement tools at the IRS also showed
increases:

The IRS filed 2.6 million levies in 2008 and 3.8 million in 2007. It filed 683,659
liens in 2007 and 768,168 liens during 2008, a substantial increase from five
years earlier.

Electronic Filing IRS Webpage

3.60 More taxpayers chose to file electronically in 2008 than during the prior year, with
58 percent of individual tax filers choosing to e-file in 2008, up from 57 percent in 2007.
More people visited the IRS internet site, IRS.gov. The IRS site was accessed more
than 217 million times in 2007 and 347 million times in 2008.

14
15
16
Table 9a. Examinat
Examination, by Typ

Typ

United States, total

Taxable returns:
u Individual income tax re
17
w Returns with total po
Table 9b. Examination Coverage: Individual Income Tax Returns
Examined, by Size of Adjusted Gross Income, Fiscal Year 2008

Returns filed in Examination

Calendar Year coverage in Fiscal
2007 (percent) [2] Year 2008 (percent)
[3]
Size of adjusted gross income [1]

All returns [4] 100.00 1.00

No adjusted gross income [5] 2.13 2.15

$1 under $25,000 40.51 0.90
$25,000 under $50,000 24.31 0.72
$50,000 under $75,000 13.44 0.69
$75,000 under $100,000 7.99 0.69
$100,000 under $200,000 8.69 0.98
$200,000 under $500,000 2.25 1.92
$500,000 under $1,000,000 0.43 2.98
$1,000,000 under $5,000,000 0.23 4.02
$5,000,000 under $10,000,000 0.02 6.47
$10,000,000 or more 0.01 9.77

Table 16. Delinquent Collection Activities,

Fiscal Years 2005-2008
[Money amounts are in thousands of dollars.]

Activity 2005 2006 2007 2008

Returns filed with additional tax due:
Total amount collected [1] [r] 27,615,348 [r] 29,172,915 [r] 31,952,399 28,465,648
Taxpayer delinquent accounts (thousands):
Number in beginning inventory 5,981 6,478 7,074 8,240
Number of new accounts 5,870 6,100 7,146 7,099
Number of accounts closed 5,373 5,504 5,980 6,107
Ending inventory:
Number 6,478 7,074 8,240 9,232
Balance of assessed tax, penalties, and interest [2] 57,594,901 69,555,590 83,488,988 94,357,717
Returns not filed timely:
Delinquent return activity:
Net amount assessed [3] 22,765,462 23,305,535 30,287,802 24,888,918
Amount collected with delinquent returns 3,584,255 3,905,764 3,968,163 3,773,528
Taxpayer delinquency investigations (thousands) [4]:
Number in beginning inventory 3,022 3,658 3,874 3,732
Number of new investigations 2,558 2,373 2,587 1,972
Number of investigations closed 1,922 2,157 2,729 2,271
Number in ending inventory 3,658 3,874 3,732 3,433
Offers in compromise (thousands) [5]:
Number of offers received 74 59 46 44
Number of offers accepted 19 15 12 11
Amount of offers accepted 325,640 283,746 228,975 200,103
Number of notices of Federal tax liens filed 522,887 629,813 683,659 768,168
Number of notices of levy served on third parties 2,743,577 3,742,276 3,757,190 2,631,038
Number of seizures 512 590 676 610

18
Table 18. Criminal Investigation Program, by Status or
Disposition, Fiscal Year 2008

Status or disposition Total Legal source tax Illegal source Narcotics-related financial crimes
crimes [1] financial crimes [2] [3]

(1) (2) (3) (4)

Investigations initiated 3,749 1,531 1,441 777

Investigations discontinued 1,259 684 409 166
Referrals for prosecution 2,785 893 1,204 688
Indictments and informations [4] 2,547 757 1,164 626
Convictions 2,144 666 958 520
Sentenced 1,957 645 864 448
Incarcerated [5] 1,583 498 696 389
Percentage of those sentenced
who were incarcerated [5]
80.9 77.2 80.6 86.8

State Information Sharing

3.70 The IRS is engaged in extensive information sharing with state tax authorities
which allows it to more effectively discover nonfilers and other tax omissions. The IRS
Fed/State Program saves government resources by partnering with state government
agencies to enhance voluntary compliance with tax laws. This includes facilitating the
exchange of taxpayer data, leveraging resources, and providing assistance to taxpayers
to improve compliance and communications.

The IRS also assists state agencies by identifying and reporting information on
emerging tax administration issues. This is accomplished through the IRS entering into
agreements to share information with the state agencies. There are more than 900 joint
efforts underway. Examples include the sharing of examination reports, abusive scheme
data, and licensing verification.

Federal Tax Returns and Return Information.

3.80 “Tax returns” include Form 1040, U.S. Individual Income Tax Return, as well as
other income tax and information returns, such as Form 941, Employer’s Quarterly
Federal Tax Return; Form 730, Tax on Wagering; Form 1120, U.S. Corporation Income
Tax Return; various Forms 1099, U.S. Information Returns; and Form W-2, Wage and
Tax Statement. The states in turn share similar return information with the IRS. Since
states have extensive information on business revenue on sales tax returns that info is
a valuable resource for discovering nonfiling and underreporting.

Return Information
3.90 “Return information” includes everything else that has anything to do with a
person’s potential tax liability. Examples are any information extracted from a return like
names of dependents, business location, or bank account information; the taxpayer's
name, mailing address, or identification number; information on whether a return has
been or will be examined or subject to any other investigation; information contained on
transcripts of accounts or on IRS computer systems; the fact of filing a return; and
whether a taxpayer has a balance due account.
19
IRS Study Provides Tax Gap Estimate
3.100 Internal Revenue Service officials have announced that they have updated their
estimates of the Tax Year 2001 tax gap based on the National Research Program
(NRP). The updated estimate of the overall gross tax gap for Tax Year 2001 – the
difference between what taxpayers should have paid and what they actually paid on a
timely basis – comes to $345 billion. This figure falls at the high end of the range of
$312 billion to $353 billion per year, an estimate released in March, 2005.

Sources of Misreporting
3.110 Though the net misreporting percentage varies by category of income, the
rates reflect that compliance is highest where there is third-party reporting or
withholding. Simply stated, compliance is highest where there is third-party
reporting.

For example, one percent of all wage, salary, and tip income is
misreported, contributing an estimated $10 billion to the tax gap. In
contrast, nonfarm sole proprietor income, which is reported on a Schedule
C and is subject to little third-party reporting or withholding, has a net
misreporting percentage of 57 percent, contributing about $68 billion to the
tax gap.

Understanding the Tax Gap

3.120 The Internal Revenue Service developed the concept of the tax gap as a way to
gauge taxpayers’ compliance with their federal tax obligations. The tax gap measures
the extent to which taxpayers do not file their tax returns and pay the correct tax on
time.

Components of the Tax Gap

3.130 The tax gap can be divided into three components:

• nonfiling,
• underreporting and
• underpayment.

Underreporting
3.140 Of these three components, underreporting of income tax, employment taxes and
other taxes represents about 80 percent of the tax gap. The single largest sub-
component of underreporting involves individuals understating their incomes, taking
improper deductions, overstating business expenses

20
and erroneously claiming credits. Individual underreporting represents about half of the
total tax gap. Individual income tax also accounts for about half of all tax liabilities.

Underreporting Is Largest Component

3.150 Underreporting noncompliance is the largest component of the tax gap.
Preliminary estimates show underreporting accounts for more than 80 percent of the
total tax gap, with non-filing and underpayment at about 10 percent each. Individual
income tax is the single largest source of the annual tax gap, accounting for about two-
thirds of the total. For individual underreporting, more than 80 percent comes from
understated income, not overstated deductions.

Noncompliance Rising
3.160 Overall, the noncompliance rate is from 15 percent to 16.6 percent of the true tax
liability. The old estimate, derived from compliance data for Tax Year 1988 and earlier,
was 14.9 percent.

Areas Where Compliance Has Decreased

3.170 Among the areas where taxpayer compliance appears to have worsened are:

• Reporting of net income from flow-through entities, such as partnerships and S

corporations
• Reporting of proprietor income and expenses, such as gross receipts, bad debts
and vehicle expenses
• Reporting of various types of deductions

21
Areas With Improved Compliance
3.180 Among the areas where compliance seems to have improved is the reporting of
farm income. Overall, compliance is highest where there is third-party reporting and/or
withholding.

For example, most wages, salaries and tip compensation are reported by
employers to the IRS through Form W-2. Preliminary findings from the
NRP indicate that less than 1.5 percent of this type of income is
misreported on individual returns. IRS researchers anticipate identifying
other specific areas of deterioration and improvement in the coming
months as they complete the detailed analysis of the study’s data.

Tax Year 2001 Gross Tax Gap by Type of Tax and Type of
Noncompliance (in $ billions

Type of Noncompliance TOTAL

Type of Tax Nonfiling Underreporti Underpaym Percent
Amou
Gap ng Gap ent Gap* Distributio
nt
n
Individual Income
25 197 23.4 245 71.1%
Tax
Corporation Income
# 30 2.3 32 9.3%
Tax
Employment Tax # 54 5.0 59 17.0%
Estate & Gift Tax 2 4 2.1 8 2.4%
Excise Tax # # 0.5 1 0.1%
TOTAL Percent 27 7.8% 285 82.5% 33.3 9.7% 345
Distribution 100.0%

Businesses More Likely to Not Comply.

3.190 Most of the understated income comes from business activities, not wages or
investment income. Compliance rates are highest where there is third-party reporting or
withholding. Preliminary findings show less than 1.5 percent of wages and salaries are
misreported.

NRP Subchapter S Corporation Study Overview

3.200 During 2007 & 2008 the IRS continued its NRP of S corporations. The study has
the following elements:

• Random Sample consists of approximately 5,000 returns from Small

Business/Self-Employed (SB/SE) and Large & Mid-Size Business (LMSB)
taxpayers covering two tax years, TY2003 and TY2004.
• The study follows the standard NRP methodology:
• Each tax year will have an examination cycle of approximately 24 months.
• The TY 2003 portion of the sample (1,200 returns) is complete, and these cases
are now in the hands of Revenue Agents.

22
 • NRP is selecting the TY 2004 (3,800 returns) portion of the sample. Expect
results by December 2008

Tax Year 2001 Gross Tax Gap by Type of Tax and IRS Operating Division (in $ billions)

IRS Operating Division TOTAL

Small Business / Self-

Tax-
Type of Tax Wage & Employed Large & Exempt Non-
Invest-
Total
Mid-Size & Gov’t Tax Compliance
Indi- Corpor- Gap
ment Busines Entities Rate
viduals ation
Individual
50 195 N/A 195 N/A N/A 245 20.9%
Income Tax
Corporation
N/A N/A 6 6 25 1 32 18.5%
Income Tax *

Employment Tax 0 40 7 47 8 4 59 8.1%

S e l f -
N/A 39 N/A 39 N/A N/A 39 51.9%
Employment
FICA and
0 1 7 8 8 4 20 3.0%
FUTA

Estate & Gift Tax # 8 N/A 8 N/A N/A 8 22.9%

Excise
0 0 0 0 0 0 1
Tax †

TOTAL Gap 50 243 14 257 34 4 345

Percent of Total 14.5% 70.5% 4.0% 74.5% 9.8% 1.2% 100.0%

Noncompliance
12.1% 27.1% 5.3% 22.3% 8.0% 3.4% 16.3%
Rate
* Unrelated Business Income Tax is shown as corporation income tax. † Includes
underpayment gap only.
# No estimate is available for this component.
Amounts may not add to totals due to rounding. Zeros indicate amounts less than $0.5 billion. See Figure 1 regarding
reliability of estimates.

23
 Tax Year 2001 Individual Income Tax Underreporting Gap and Net Misreporting
Percentage (NMP) Associated with Income and Offset Line Items

Type of Income or Offset

Underreporting Net
Gap ($B) Misreporting
Percentage †
Total Underreporting Gap 197 18%
Underreported Income 166 11%
Non-Business Income 56 4%
Wages, salaries, tips 10 1%
Interest income 2 4%
Dividend income 1 4%
State income tax refunds 1 12%
Alimony income * 7%
Pensions & annuities 4 4%
Unemployment compensation * 11 %
Social Security benefits 1 6%
Capital gains 11 12%
Form 4797 income 3 64%
Other income 23 64%
Business Income 109 43%
Non-farm proprietor income 68 57%
Farm income 6 72%
Rents & royalties 13 51%
Partnership, S-Corp, 22 18%
Estate & Trust, etc.
Overreported Offsets to Income 15 4%
Adjustments -3 -21 %
SE Tax deduction§ -4 -51%
All other adjustments 1 6%
Deductions 14 5%
Exemptions 4 5%
Credits 17 26%
Net Math Errors (non-EITC) *
† The amount of income or offset misreported divided by the amount that should have been reported. The NRP contains an adjustment
for income amounts that were underreported, but does not have a corresponding adjustment for offset amounts that were not
claimed.
* Less than $0.5 billion.
§ Taxpayers understate this adjustment because they understate their self-employment income and, thereby, their self-
employment tax. Therefore, the gap associated with this item is negative.

24
25
2009 Budget
3.210 The Internal Revenue Service will hire more than 3,500 frontline enforcement
employees as it embarks on its largest hiring initiative in recent history, Deputy
Commissioner for Services and Enforcement Linda E. Stiff said March 30. This number
includes more than 2,000 new revenue agents and revenue officers, Stiff said during a
luncheon at the Tax Executives Institute's 59th Midyear Conference. Several hundred of
these new hires will be directed at large corporate compliance, and as many as 700 will
be hired to deal with international issues, she said.

The hiring push comes on the heels of the fiscal year 2009 omnibus bill, which contains
$630 million above IRS's current funding level for it to address noncompliance through
improved technology, collection efforts, and audits, Stiff said. The Obama administration
and the Treasury Department are strongly supporting IRS in its efforts to combat
abuses in the international arena, Stiff said. IRS's strategy in this area includes an
integrated approach composed of separate yet complementary programs, such as
international collaboration and information sharing, as well as information reporting and
withholding, she said.1

2009 Budget
3.220 The FY 2009 President’s Budget for the IRS increased funding as part of a
strategy to improve compliance by focusing on the following priorities:

• Improving voluntary compliance and reducing the tax gap by:

• Increasing front-line enforcement resources,

• Improving taxpayer service options,

• Enhancing research, and

• Implementing legislative and regulatory changes.

• Maintaining balance between taxpayer service and enforcement.

• Investing in technology to improve infrastructure, modernize, and increase the

productivity of existing resources.

1
Mar. 31 -- BNA, Inc. Daily Tax Report

26
Overview - Abusive Return Preparer

27
3.230 The IRS continues to expand and enhance its abusive preparer program. The
program was developed to enhance compliance in the return-preparer community by
engaging in enforcement actions and/or asserting appropriate civil penalties against
unscrupulous or incompetent return preparers. Bad preparers are a significant problem
for both the IRS and taxpayers.

Return preparer fraud generally involves the preparation and filing of false income tax
returns by preparers who claim inflated personal or business expenses, false
deductions, unallowable credits or excessive exemptions on returns prepared for their
clients. This includes inflated requests for the special one-time refund of the long-
distance telephone tax. Preparers may also manipulate income figures to obtain tax
credits, such as the Earned Income Tax Credit, fraudulently.

In some situations, the client (taxpayer) may not have knowledge of the false expenses,
deductions, exemptions and/or credits shown on their tax returns. However, when the
IRS detects the false return, the taxpayer — not the return preparer — must pay the
additional taxes and interest and may be subject to penalties.

Abusive Preparer Prosecutions

FY 2008 FY 2007 FY 2006

Investigations Initiated 214 218 197

Prosecution Recommendations 134 196 153

Indictments/Informations 142 131 135

Sentenced 124 123 109

Incarceration Rate* 81.5% 81.3% 89.0%

Avg. Months to Serve 18 19 18

Audits of 30 Clients
3.240 Another aspect of the IRS preparer program is identifying suspect preparers and
audited their clients. If during an examination a revenue suspects that some of the
deficiencies on a return were caused by the preparer she can refer the matter to an
area coordinator. After review the coordinator can initiate a project on the preparer. The
preparer is sent a letter notifying her that she has been selected for a project and 30 of
her client's returns are audited. If significant deficiencies are found then the IRS may
choose one of several courses of action including:

• Referral to Criminal investigation

• Referral to the office of professional liability
• Preparer penalties
• Referral to Department of justice to seek an injunction ordering the preparer to
cease filing tax returns.

28
4. EXAMINATION

Examination Reengineering
4.10 Changes to the tax law, technology, and the business environment necessitated
the IRS to make changes to its examination process. SB/SE initiated Examination
Reengineering in order to improve the quality and consistency of its examinations
across the country. SB/SE gathered feedback from multiple sources to design the new
field and office examination processes. Since 2003 the IRS has been implementing this
process.

Some of the features of the reengineered field examination process are:

• Clearly communicated expectations of both the taxpayer and field agent through
mandatory discussions between the revenue agent and taxpayer regarding the
specific examination issues, required documentation, and a mutually agreed
upon date to complete the examination.

• At the beginning of each examination, field agents and their managers will meet
to discuss the agent’s approach to the examination, the plan to close the
examination, and the mutual commitment date arrived at with the taxpayer.

• Field agents will use standardized templates for every examination issue to
gather the information necessary to resolve issues. Agents will use a
standardized guide when deciding if additional issues need to be added to the
examination. The agent will explain to the taxpayer if any additional issues are
included in the examination.

The Dirty Dozen

4.20 Each year the IRS announces its Dirty Dozen and urges people to avoid these
common schemes: The 2009 list was as follows:

1. Phishing is a tactic used by Internet-based scam artists to trick

unsuspecting victims into revealing personal or financial information. The
criminals use the information to steal the victim’s identity, access bank accounts,
run up credit card charges or apply for loans in the victim’s name.

Phishing scams often take the form of an e-mail that appears to come from a
legitimate source, including the IRS. The IRS never initiates unsolicited e-mail
contact with taxpayers about their tax issues. Taxpayers who receive unsolicited
e-mails that claim to be from the IRS can forward the message to
phishing@irs.gov. Further instructions are available at IRS.gov. To date,
taxpayers have forwarded scam e-mails reflecting thousands of confirmed IRS
phishing sites. If you believe you have been the target of an identity thief,
information is available at IRS.gov.

2. Hiding Income Offshore The IRS aggressively pursues taxpayers and

promoters involved in abusive offshore transactions. Taxpayers have tried to
avoid or evade U.S. income tax by hiding income in offshore banks, brokerage

29
accounts or through other entities. Recently, the IRS provided guidance to
auditors on how to deal with those hiding income offshore in undisclosed
accounts. The IRS draws a clear line between taxpayers with offshore accounts
who voluntarily come forward and those who fail to come forward.

Taxpayers also evade taxes by using offshore debit cards, credit cards, wire
transfers, foreign trusts, employee-leasing schemes, private annuities or life
insurance plans. The IRS has also identified abusive offshore schemes including
those that involve use of electronic funds transfer and payment systems, offshore
business merchant accounts and private banking relationships.

3. Filing False or Misleading Forms The IRS is seeing scam artists file
false or misleading returns to claim refunds that they are not entitled to. Frivolous
information returns, such as Form 1099-Original Issue Discount (OID), claiming
false withholding credits are used to legitimize erroneous refund claims. The new
scam has evolved from an earlier phony argument that a “strawman” bank
account has been created for each citizen. Under this scheme, taxpayers
fabricate an information return, arguing they used their “strawman” account to
pay for goods and services and falsely claim the corresponding amount as
withholding as a way to seek a tax refund.

4. Abuse of Charitable Organizations and Deductions The IRS continues

to observe the misuse of tax-exempt organizations. Abuse includes
arrangements to improperly shield income or assets from taxation and attempts
by donors to maintain control over donated assets or income from donated
property. The IRS also continues to investigate various schemes involving the
donation of non-cash assets, including easements on property, closely-held
corporate stock and real property. Often, the donations are highly overvalued or
the organization receiving the donation promises that the donor can purchase the
items back at a later date at a price the donor sets. The Pension Protection Act of
2006 imposed increased penalties for inaccurate appraisals and new definitions
of qualified appraisals and qualified appraisers for taxpayers claiming charitable
contributions.

5. Return Preparer Fraud Dishonest return preparers can cause many

headaches for taxpayers who fall victim to their ploys. Such preparers derive
financial gain by skimming a portion of their clients’ refunds and charging inflated
fees for return preparation services. They attract new clients by promising large
refunds. Taxpayers should choose carefully when hiring a tax preparer. As the
saying goes, if it sounds too good to be true, it probably is. No matter who
prepares the return, the taxpayer is ultimately responsible for its accuracy. Since
2002, the courts have issued injunctions ordering dozens of individuals to cease
preparing returns, and the Department of Justice has filed complaints against
dozens of others, which are pending in court.

6. Frivolous Arguments Promoters of frivolous schemes encourage people

to make unreasonable and unfounded claims to avoid paying the taxes they owe.
The IRS has a list of frivolous legal positions that taxpayers should stay away
from. Taxpayers who file a tax return or make a submission based on one of the
30
positions on the list are subject to a $5,000 penalty. More information is available
on IRS.gov.

7. False Claims for Refund and Requests for Abatement This scam
involves a request for abatement of previously assessed tax using Form 843,
Claim for Refund and Request for Abatement. Many individuals who try this have
not previously filed tax returns. The tax they are trying to have abated has been
assessed by the IRS through the Substitute for Return Program. The filer uses
Form 843 to list reasons for the request. Often, one of the reasons given is
"Failed to properly compute and/or calculate Section 83-Property Transferred in
Connection with Performance of Service."

8. Abusive Retirement Plans The IRS continues to uncover abuses in

retirement plan arrangements, including Roth Individual Retirement
Arrangements (IRAs). The IRS is looking for transactions that taxpayers are
using to avoid the limitations on contributions to IRAs as well as transactions that
are not properly reported as early distributions. Taxpayers should be wary of
advisers who encourage them to shift appreciated assets into IRAs or companies
owned by their IRAs at less than fair market value to circumvent annual
contribution limits. Other variations have included the use of limited liability
companies to engage in activity which is considered prohibited.

9. Disguised Corporate Ownership Some taxpayers form corporations and

other entities in certain states for the primary purpose of disguising the ownership
of a business or financial activity. Such entities can be used to facilitate
underreporting of income, fictitious deductions, non-filing of tax returns,
participating in listed transactions, money laundering, financial crimes, and even
terrorist financing. The IRS is working with state authorities to identify these
entities and to bring the owners of these entities into compliance.

10. Zero Wages Filing a phony wage- or income-related information return to

replace a legitimate information return has been used as an illegal method to
lower the amount of taxes owed. Typically, a Form 4852 (Substitute Form W-2)
or a “corrected” Form 1099 is used as a way to improperly reduce taxable
income to zero. The taxpayer also may submit a statement rebutting wages and
taxes reported by a payer to the IRS. Sometimes fraudsters even include an
explanation on their Form 4852 that cites statutory language on the definition of
wages or may include some reference to a paying company that refuses to issue
a corrected Form W-2 for fear of IRS retaliation. Taxpayers should resist any
temptation to participate in any of the variations of this scheme.

11. Misuse of Trusts For years, unscrupulous promoters have urged

taxpayers to transfer assets into trusts. While there are many legitimate, valid
uses of trusts in tax and estate planning, some promoted transactions promise
reduction of income subject to tax, deductions for personal expenses and
reduced estate or gift taxes. Such trusts rarely deliver the promised tax benefits
and are being used primarily as a means to avoid income tax liability and hide
assets from creditors, including the IRS.

31
 The IRS has recently seen an increase in the improper use of private annuity
trusts and foreign trusts to divert income and deduct personal expenses. As with
other arrangements, taxpayers should seek the advice of a trusted professional
before entering into a trust arrangement.

12. Fuel Tax Credit Scams The IRS is receiving claims for the fuel tax credit
that are unreasonable. Some taxpayers, such as farmers who use fuel for off-
highway business purposes, may be eligible for the fuel tax credit. But some
individuals are claiming the tax credit for nontaxable uses of fuel when their
occupation or income level makes the claim unreasonable. Fraud involving the
fuel tax credit is considered a frivolous tax claim, potentially subjecting those who
improperly claim the credit to a $5,000 penalty.

5. APPEALS

Strategic Priorities:
5.10 Appeals has set forth the following as its strategic priorities for 2009:

• Increase taxpayer awareness of the Appeals process and their rights within the
process
• Increase taxpayer awareness of alternative dispute resolution programs
• Improve our processes to meet customer needs and expectations and to reduce
the length of the Appeals process while spending the right amount of time with
each taxpayer
• Promote employee productivity, engagement, and satisfaction

Campus Appeals Program

5.20 The campus appeals program diminishes taxpayer rights. Any appeal from a
compliance generated notice is assigned to the campus appeals program. The campus
appeals personnel are poorly trained and lack field experience. Their incompetence
starkly contrasts with the well trained experienced former revenue agents and revenue
officers assigned to the local appeals offices. When your client receives a notice from a
campus allowing an appeal your protest should always request that your client be given
a face to face conference in your local office.

OIC and TFRP Mediation and Arbitration

5.30 During a test period which began in December 2008 Appeals will seek
appropriate OIC and TFRP cases for both mediation and arbitration during the two-year
test period in order to evaluate the effectiveness of alternative dispute resolution for
such cases.

During the two-year test period, effective from the date of publication of this
announcement, Appeals will initially offer mediation and arbitration for OIC and TFRP
cases for taxpayers whose appeals are considered at an Appeals office located in one
of the following cities:

32
 Atlanta, Georgia
Chicago, Illinois
Cincinnati, Ohio
Houston, Texas
Indianapolis, Indiana
Louisville, Kentucky
Phoenix, Arizona
San Francisco, California

Application Process
5.40 Either the taxpayer or Appeals may submit a request to mediate or arbitrate after
consulting with and obtaining the concurrence of the other party. A taxpayer may submit
a request to mediate or arbitrate by sending a written request to the appropriate
Appeals Team Manager and a copy to:

Chief of Appeals
Attn: Tax Policy & Procedure —
Collection & Processing
1099 14th St. NW, Suite 4200 East
Washington, DC 20005

For an OIC case, the written request to mediate or arbitrate should include:

►The taxpayer’s name, address, and taxpayer identification number, and the
name, title, address, and telephone number of the person to contact;
►The name of the Appeals Team Manager, Appeals Officer, or Settlement
Officer;
►The taxable periods involved;
►A detailed description of the issue(s) for which the taxpayer is requesting
mediation or arbitration, including both the specific dollar amount and the basis
by which that amount was determined; and
►A representation that the disputed issue is not an excluded issue listed in
section 4.01 above or in Revenue Procedure 2002-44 or Revenue Procedure
2006-44.

TFRP
5.50 For a TFRP case, the written request to mediate or arbitrate should contain items
above and a detailed explanation of the taxpayer’s position, including explanations of
the following (where applicable):

►Why the taxpayer was not required to collect, truthfully account for, and pay
over the income, employment or excise taxes;
►Why the taxpayer did not willfully fail to collect or truthfully account for and pay
over such tax, or willfully attempt in any manner to evade or defeat the payment
of such tax; and
►Why the computation of the Trust Fund Recovery Penalty should reflect
payment(s) designated specifically to the trust fund portion of the unpaid tax.

33
If the taxpayer wants to use a non-IRS co-mediator (at the taxpayer’s expense) or a
non-IRS arbitrator (expense shared equally by the taxpayer and Appeals), the
application should state this preference.

Table 21. Appeals Workload, by Type of Case, Fiscal

Year 2008

Type of case Cases Cases Cases pending

received [1] closed [1] September 30, 2008 [1]

(1) (2) (3)

Total cases [2] 115,819 106,722 59,899

Examination 42,990 37,354 28,565

Collection due process 35,760 33,981 16,601
Offers in compromise 10,558 10,311 4,865
Penalty appeals 10,365 9,139 3,590
Innocent spouse 4,041 3,993 2,237
Industry cases 1,398 1,288 1,593

6. USEFUL INFORMATION FOR PRACTITIONERS

Whistleblower Reforms
6.10 Tax Relief and Health Care Act of 2006 reforms the reward program for
individuals who provide information to IRS regarding violations of the tax laws for
information provided on or after the enactment date. Specifically, the Act establishes a
reward range for such 'whistleblowers' of 15% to 30% of proceeds collected by IRS
(subject to certain exceptions) where the amount in dispute exceeds $2,000,000. For
awards for individuals the income must exceed $200,000. It also provides IRS with
regulatory authority to create a Whistleblower Office to administer the program. ( Code
Sec. 7623, as amended by Act Sec. 406) An above-the-line deduction is allowed for
attorneys' fees and court costs related to whistleblower rewards (Code Sec. 62(a)(21),
as amended by Act Sec. 406(a)(3)).

Mortgage Relief Act

6.20 The Mortgage Relief Act, effective for indebtedness discharged on or after Jan.
1, 2007 and before Jan. 1, 2010, generally allows taxpayers to exclude up to $2 million
of mortgage debt forgiveness on their principal residence. Specifically, under the
Mortgage Relief Act, gross income doesn't include any discharge of qualified principal
residence indebtedness. (Code Sec. 108(a)(1)(E)) Qualified principal residence
indebtedness is acquisition indebtedness under Code Sec. 163(h)(3)(B) with respect to
the taxpayer's principal residence, but with a $2 million limit ($1 million for married
individuals filing separately). (Code Sec. 108(h)(2)) “Principal residence” has the same
meaning as under the home sale exclusion rules of Code Sec. 121. (Code Sec. 108(h)
(5)) Acquisition indebtedness of a principal residence is indebtedness incurred in the
acquisition, construction, or substantial improvement of an individual's principal
residence that is secured by the residence. It includes refinancing of debt to the extent

34
the amount of the refinancing doesn't exceed the amount of the refinanced
indebtedness. (Joint Committee on Taxation JCX-86-07)

Basis Reduction
6.30 The basis of the taxpayer's principal residence is reduced by the excluded
amount, but not below zero. (Code Sec. 108(h)(1))

Qualified Principal Residence Indebtedness

6.40 If any loan is discharged, in whole or in part, and only part of the loan is qualified
principal residence indebtedness, the mortgage forgiveness exclusion applies only to so
much of the amount discharged as exceeds the amount of the loan (as determined
immediately before the discharge) which is not qualified principal residence
indebtedness. (Code Sec. 108(h)(4)) The exclusion doesn't apply to a loan discharged
on account of services performed for the lender or any other factor not directly related to
a decline in the value of the residence or to the taxpayer's financial condition. The
exclusion also doesn't apply to a taxpayer in a Title 11 bankruptcy. (Code Sec. 108(h)
(3)) An insolvent taxpayer (other than one in a Title 11 bankruptcy) can elect to have the
mortgage forgiveness exclusion not apply and can instead rely on the Code Sec. 108(a)
(1)(B) exclusion for insolvent taxpayers. (Code Sec. 108(a)(2))

Misclassified Workers
6.50 Employees working for employers who failed to withhold Social Security and
Medicare taxes should use new Form 8919 to report and pay their share of these taxes.
This includes section 530 employees — that is, people who work for employers claiming
relief from federal payroll taxes under section 530 of the Revenue Act of 1978. It also
includes employees who are treated as independent contractors but who have received
a determination letter from the IRS which states they are employees.

Workers who believe they are misclassified as independent contractors can file Form
SS-8 with the IRS and request a determination of their worker classification. For
employees, the Social Security tax rate is 6.2 percent and the Medicare tax rate is 1.45
percent. Normally, employers withhold these taxes from workers’ pay, match these
amounts and turn over the combined amounts to the IRS. Workers, properly classified
as independent contractors, should not use Form 8919 but instead, continue to use
Schedule SE. IRS Publication 1779 has further details on employee versus independent
contractor status.

Misclassification
6.60 A 2009 TIGTA report says IRS still needs to do more to identify misclassified
workers [Audit Report No. 2009-30-035]: The Treasury Inspector General for Tax
Administration (TIGTA) has issued an audit report that evaluates the effectiveness of
IRS actions with respect to identifying misclassified workers. The report notes that the
“misclassification of employees as independent contractors is a nationwide issue
affecting millions of workers that continues to grow and contribute to the tax gap.”
Workers are frequently misclassified for a variety of reasons, either intentionally to save
costs, or unintentionally because of a lack of knowledge. Some independent contractor
misclassifications occur because certain employers are protected from potentially large
employment tax assessments by Section 530 of the Revenue Act of 1978. The report
notes that the IRS' interest in this issue is not to reclassify workers from independent
35
contractors to employees. Rather, it is to ensure that employers are making the proper
determinations and that workers are being treated appropriately. The report states that
while the IRS has done a great deal to educate employers about proper classification of
workers, much more needs to be done. For example, studies of the impact of
misclassification on the tax gap are more than twenty years old. Therefore, it is difficult
for the IRS to estimate the size of the problem today, or the overall effectiveness that its
actions to date are having. The most recent IRS estimate of the tax gap is $345 billion,
with an estimated $1.6 billion resulting from worker misclassification. However, the $1.6
billion figure is based on 1984 data, and is likely to be a great deal higher now.

Recommendations
6.70 TIGTA recommends that the IRS develop an agency-wide employment tax
program to coordinate the decision-making process and efforts among its business
divisions. The report also recommends that the IRS Deputy Commissioner for Services
and Enforcement (DCSE) conduct a formal compliance study to measure the current
impact of worker misclassification on the tax gap. The IRS concurred with the findings in
the audit report. DCSE will coordinate an agency-wide employment tax program. The
Director of Specialty Programs for the IRS Small Business/Self-Employed Division will
coordinate a study in fiscal year 2009 on worker classification and other employment tax
issues. The planning for this project has already begun.

UBS Criminal Charges

6.80 On February 18, 2009 UBS AG, Switzerland’s largest bank, IRS announced that
it had entered into a deferred prosecution agreement on charges of conspiring to
defraud the United States by impeding the Internal Revenue Service (IRS),.

Agreement
6.90 As part of the deferred prosecution agreement and in an unprecedented move,
UBS, based on an order by the Swiss Financial Markets Supervisory Authority (FINMA),
has agreed to immediately provide the United States government with the identities of,
and account information for, certain United States customers of UBS’s cross-border
business. Under the deferred prosecution agreement, UBS has also agreed to
expeditiously exit the business of providing banking services to United States clients
with undeclared accounts. As part of the deferred prosecution agreement, UBS has
further agreed to pay $780 million in fines, penalties, interest and restitution.

Allegations
6.100 Justice Department alleges that Swiss bankers routinely traveled to the United
States to market Swiss bank secrecy to United States clients interested in attempting to
evade United States income taxes. Court documents assert that, in 2004 alone, Swiss
bankers allegedly traveled to the United States approximately 3,800 times to discuss
their clients’ Swiss bank accounts. The information further alleges that UBS managers
and employees used encrypted laptops and other counter-surveillance techniques to
help prevent the detection of their marketing efforts and the identities and offshore
assets of their U.S. clients. According to the information, clients of the cross-border
business in turn filed false tax returns which omitted the income earned on their Swiss
bank accounts and failed to disclose the existence of those accounts to the IRS.

36
Prior Charges
6.110 In November 2008, UBS executive Raoul Weil was indicted by a federal grand
jury in Fort Lauderdale and charged with conspiring to defraud the United States for his
alleged role in overseeing the United States cross-border business. The district court
recently declared him to be a fugitive.

In June 2008, former UBS private banker Bradley Birkenfeld pleaded guilty to a charge
of conspiring to defraud the United States for similar conduct. Birkenfeld is scheduled to
be sentenced on May 1, 2009. Also, in June 2008, the U.S. District Court in Miami
authorized the Internal Revenue Service to serve upon UBS a so-called “John Doe”
summons seeking records that would identify United States taxpayers with accounts at
UBS in Switzerland who have elected to conceal the existence of their accounts from
the IRS.

Comments of Government Officials

6.120 “Today’s agreement is but one milestone in an ongoing law enforcement effort to
reassure hard-working and law-abiding taxpayers who pay their fair share of taxes that
those who don’t will pay a heavy price,” said John A. DiCicco, Acting Assistant Attorney
General of the Justice Department’s Tax Division. “The veil of secrecy has been pulled
aside and we will continue to aggressively pursue those who shirk their federal tax
obligations or assist others in doing so.”

“UBS executives knew that UBS’s cross-border business violated the law,” said R.
Alexander Acosta, U.S. Attorney for the Southern District of Florida. “They refused to
stop this activity, however, and in fact instructed their bankers to grow the business. The
reason was money -- the business was too profitable to give up. This was not a mere
compliance oversight, but rather a knowing crime motivated by greed and disrespect of
the law.”

Settlement Offer Unreported Offshore Income

6.130 On March 26, 2008 IRS Commissioner Doug Shulman announced what is in
effect a settlement offer for those that voluntarily and timely disclose unreported
offshore income. Those meeting the terms of the offer will have to pay back-taxes and
interest for six years, and pay either an accuracy or delinquency penalty on all six years.
They will also pay a penalty of 20% of the amount in the foreign bank accounts in the
year with the highest aggregate account or asset value. In other words, 20% of the
highest asset value of an account anytime in the past six years. However, those who
come forward on a timely basis will not face criminal prosecution. The offer is only open
for 6 months.

Highlights of the Offer.

6.140 As explained in a memorandum written by Linda E. Stiff, Deputy Commissioner
for Services and Enforcement and addressed to the Commissioners for the Large and
Mid-Size (LMSB) and Small Business/Self-Employed (SBSE) Divisions, the tax liabilities
related to offshore issues of taxpayers that make “voluntary disclosure requests'” will be
settled as follows:

37
 ►Taxes and interest due going back 6 years will be assessed.
►The taxpayer must file or amend all returns, including information returns, and
Form TD F 90-22.1 (FBAR).

Penalties
6.150 IRS will assess either an accuracy or delinquency penalty for all years (no
reasonable cause exception will be applied).

In lieu of all other penalties that may apply (including FBAR and information return
penalties), IRS well assess a penalty equal to 20% of the amount in foreign bank
accounts/entities in the year with the highest aggregate account/asset value. The
penalty is reduced to 5% if, with respect to the accounts or entities formed: (a) the
taxpayer did not open them or cause them to be opened or formed; (b) there has been
no activity during the period the accounts/entities were controlled by the taxpayer; and
(c) all applicable U.S. taxes have been paid on the funds in the accounts/entities (where
only the earnings have escaped U.S. taxes).

Fully Cooperate
6.160 The above terms will apply only to taxpayers that “fully cooperate with the IRS
both civilly and criminally,” for all voluntary disclosure requests that are submitted to
IRS, and are not yet resolved. The terms will remain in effect only for six months from
Mar. 23, 2009 (the date that the Deputy Commissioner for Services and Enforcement
released the memorandum on voluntary disclosure requests). IRS Commissioner Doug
Shulman says that after that time, IRS would reevaluate all of its options, and warned
that for those “who continue to hide their heads in the sand, the situation will only
become more dire.”

VITA Grant Program

6.170 In December 2007, Congress appropriated funds to the IRS to establish and
administer a one-year matching grant program, in consultation with the Taxpayer
Advocate Service, for the Community Volunteer Income Tax Assistance Program. The
Report to Congress provides more information on the design plan.

This grant program is intended to provide direct funds to organizations to:

Enable VITA Programs to extend services to underserved populations in hardest-

to-reach areas, both urban and non-urban
Increase the capacity to file returns electronically
Heighten quality control
Enhance volunteer training
Significantly improve the accuracy rate of returns prepared at volunteer sites

Refer to the Publication 4671 (VITA Grant Program Overview and Application Package)
and to the frequently asked questions for more information on the VITA Grant Program.
Questions about the VITA Grant Program may be emailed to the
Grant.Program.Office@irs.gov.

38
Identity Theft
6.180 Identity theft is becoming a huge problem for the tax system. The IRS has
established a new office for reporting. identity theft using stolen SSN’s. Their employers
report that income to the IRS on W-2’s and the income is attributed to the theft victim.
Two scenarios are most common:

►The taxpayer receives an audit notice from the IRS showing that he is working
several jobs in many states or;
►The taxpayer attempts to file a return and it is rejected by the IRS because
someone has already filed a return using the taxpayers SSN.

The IRS website now gives taxpayers who are the victims of identity theft the
following advice:

Identity Theft and Your Tax Records

The IRS does not initiate communication with taxpayers through e-mail. Before identity
theft happens, safeguard your information.

What do I do if the IRS contacts me because of a tax issue that may have been
created by an identity theft?

If you receive a notice or letter in the mail from the IRS that leads you to believe
someone may have used your Social Security number fraudulently, please
respond immediately to the name, address, and/or number printed on the IRS
notice.

Be alert to possible identity theft if the IRS issued notice or letter:

►states more than one tax return was filed for you, or
►indicates you received wages from an employer unknown to you.
►An identity thief might also use your Social Security number to file a tax return
in order to receive a refund. If the thief files the tax return before you do, the IRS
will believe you already filed and received your refund if eligible.

If your Social Security number is stolen, it may be used by another individual to get a
job. That person’s employer would report income earned to the IRS using your Social
Security number, making it appear that you did not report all of your income on your tax
return.

If you have previously been in contact with the IRS and have not achieved a resolution,
please contact the IRS Identity Protection Specialized Unit, toll-free at 1-800-908-4490.

What do I do if I have not been contacted by IRS for a tax issue but believe I am a
victim of identity theft?

If your tax records are not currently affected by identity theft, but you believe you
may be at risk due to a lost/stolen purse or wallet, questionable credit card

39
 activity, credit report, or other activity, you need to provide the IRS with proof of
your identity.

You should submit a copy, not the original documents, of your valid Federal or
State issued identification, such as a social security card, driver's license, or
passport, etc, along with a copy of a police report or Federal Trade Commission
Identity Theft Affidavit. If the FTC Affidavit is not notarized, a witness (non-
relative) must sign it.

Please send these documents using one of the following options:

Mailing address:
Internal Revenue Service
P.O. Box 9039
Andover, MA 01810-0939

FAX: Note that this is not a toll-free FAX number

1-978-247-9965

For your convenience, Form 14026 is available as a cover sheet for submitting your
documentation.

You may also contact the IRS Identity Protection Specialized Unit, toll-free
1-800-908-4490 for guidance.

Hours of Operation: Monday – Friday, 8:00 a.m. – 8:00 p.m. your local time (Alaska &
Hawaii follow Pacific Time).

40
IRS Hotlines and Toll-Free Numbers
IRS Telephone Lines and Hours of Operation

Service Telephone Hours of operation

number

Practitioner Priority Service (866) 860-4259 M–F, 8:00 a.m.–8:00 p.m., local time

IRS Tax Help Line for Individuals (800) 829-1040 M–F, 7:00 a.m.–10:00 p.m., local time

Business and Specialty Tax Line (800) 829-4933 M–F, 7:00 a.m.–10:00 p.m., local time

e-Help (Practitioners Only) (866) 255-0654 M–F, 6:30 a.m.–6:00 p.m., CT

(non-peak period)
M-F, 6:30 a.m.–10:00 p.m, CT (1/12/2007
– 4/27/2007)
and Saturdays 6:30 a.m. – 4:00 p.m., CT
(1/12/2007 – 4/27/2007)

Identity Protection Specialized Unit 1-800-908-4490M – F, 8:00 a.m. – 8:00 p.m. local time

Refund Hotline (800) 829-1954 Automated service is available 24/7

Forms and Publications (800) 829-3676 M–F, 7:00 a.m–10:00 p.m., local time

National Taxpayer Advocate Help (877) 777-4778 M–F, 7:00 a.m.–10:00 p.m., local time
Line

Telephone Device for the Deaf (800) 829-4059 M–F, 7:00 a.m.–10:00 p.m., local time
(TDD): Forms, Tax Help, TAS

Electronic Federal Tax Payment (800) 555-4477 24/7

System

Government Entities (TEGE) Help (877) 829-5500 M–F, 8:30 a.m. – 4:30 p.m., ET
Line

TeleTax Topics and Refund Status (800) 829-4477 24/7

Forms 706 and 709 Help Line (866) 699-4083 M–F, 7:00 a.m.–7:00 p.m., local time

Employer Identification Number (800) 829-4933 M–F, 7:00 a.m.–10:00 p.m., local time
(EIN)

Excise Tax and Form 2290 Help (866) 699-4096 M–F, 8:00 a.m.–6:00 p.m., ET
Line

Information Return Reporting (866) 455-7438 M–F, 8:30 a.m.–4:30 p.m., ET

41
7. COLLECTION

Taxpayer Advocate’s Report On Enforced Collection

7.10 The Taxpayer Advocate has issued the following report to Congress:
“While the history of the partial-payment installment agreement program is much briefer,
the aggregate data indicate that it, too, is not widely utilized. Indeed, most taxpayers
and many practitioners are not even aware it exists. What has the IRS done instead
with respect to taxpayers with delinquent accounts? In FY 2008, it placed one million
taxpayers into “currently not collectible” status – meaning that the IRS is collecting
nothing at all30 – and it took traditional enforcement actions about 3.4 million times,
imposing 2,631,038 levies, placing 768,168 liens, and conducting 610 property
seizures.

IRS data show that greater use of traditional enforcement tools like liens and levies
does not have a significant impact on overall collection. For example, the number of
levies the IRS has imposed plummeted from 3,659,000 in FY 1997 just before the IRS
Restructuring and Reform Act of 1998 (RRA ’98), to 220,000 in FY 2000, and then
climbed back up to 3.76 million in FY 2007.32. Yet the IRS collection yield has risen on
a slow, relatively consistent and gradual path over that period of time with no
discernable revenue loss resulting from the post-RRA ’98 reduction in levies, as shown
by the following chart.

Flawed Private Collection Ends

7.20 In March, 2009 the IRS announced that after an extensive review of the private
debt collection program, including its cost effectiveness, IRS won't renew its contracts
with two private debt collection agencies.

From the start private collection agencies have been controversial. While hailed by
some as an opportunity to improve government service by utilizing more efficient and
more motivated private enterprises, it has also been criticized by others as a misguided
and inefficient effort to privatize government.

42
The American Jobs Creation Act of 2004 (Jobs Act) allowed IRS to use private
companies to collect taxes owed to the federal government by providing that nothing in
any provision of law may be construed to prevent IRS from entering into a qualified tax
collection contract. (Code Sec. 6306(a), as added by Act Sec. 881(a)(1)) The private
collection agency could keep and use up to 25% of the amount collected under qualified
tax collection contract for the costs of services performed under the contract. The
amount credited as paid by any taxpayer is determined without regard to these rules on
fees and expenses. (Code Sec. 6306(c))

End of programs. IRS determined that the tax collection work is best done by IRS
employees who have more flexibility handling cases, which is particularly important with
many taxpayers currently facing economic hardship. Accordingly, it won't renew the
current one-year contracts with two private debt collectors that expire on Mar. 6, 2009.
IRS Commissioner Doug Shulman cited the results of a cost-effectiveness study of the
private debt collection program (which was supported by an independent review) that
showed that it was reasonable to conclude that when working similar inventory, IRS
collection was more cost effective than the private contractors. He noted that IRS
anticipates hiring over 1,000 new collection personnel in FY 2009.

Help for People Who Owe Taxes

7.30 With many people facing additional financial difficulties, in February 2009 the IRS
is taking several additional steps to help people who owe back taxes.

“We need to ensure that we balance our responsibility to enforce the law with the
economic realities facing many American citizens today,” Shulman said. “We want to go
the extra mile to help taxpayers, especially those who’ve done the right thing in the past
and are facing unusual hardships.”

On a wide range of situations, IRS employees have flexibility to work with struggling
taxpayers to assist them with their situation. Depending on the circumstances,
taxpayers in hardship situations may be able to adjust payments for back taxes, avoid
defaulting on payment agreements or possibly defer collection action.

Flexibility
7.40 Among the areas where the IRS can provide assistance:

Postponement of Collection Actions: IRS employees will have greater

authority to suspend collection actions in certain hardship cases where taxpayers
are unable to pay. This includes instances when the taxpayer has recently lost a
job, is relying solely on Social Security or welfare income or is facing devastating
illness or significant medical bills. If an individual has recently encountered this
type of financial problem, IRS assistors may be able to suspend collection
without documentation to minimize burden on the taxpayer.

Added Flexibility for Missed Payments: The IRS is allowing more flexibility for
previously compliant individuals in existing Installment Agreements who have
difficulty making payments because of a job loss or other financial hardship. The
IRS may allow a skipped payment or a reduced monthly payment amount without

43
 automatically suspending the Installment Agreement. Taxpayers in a difficult
financial situation should contact the IRS.

Additional Review for Offers in Compromise on Home Values: The equity

taxpayers have in real property can be a barrier to an OIC being accepted. With
the uncertainty in the housing market, the IRS recognizes that the real-estate
valuations used to assess ability to pay may not be accurate. So in instances
where the accuracy of local real-estate valuations is in question or other unusual
hardships exist, the IRS is creating a new second review of the information to
determine if accepting an offer is appropriate.

Prevention of Offer in Compromise Defaults: Taxpayers who are unable to

meet the periodic payment terms of an accepted OIC will be able to contact the
IRS office handling the offer for available options to help them avoid default.

Expedited Levy Releases: The IRS will speed the delivery of levy releases by
easing requirements on taxpayers who request expedited levy releases for
hardship reasons. Taxpayers seeking expedited releases for levies to an
employer or bank should contact the IRS number shown on the notice of levy to
discuss available options. When calling, taxpayers requesting a levy release due
to hardship should be prepared to provide the IRS with the fax number of the
bank or employer processing the levy.

Online Payment Agreement (OPA)

7.50 The Internal Revenue Service today introduced several new features to the
interactive Online Payment Agreement application, which will make it easier for
taxpayers and their authorized representatives to make changes to existing installment
agreements.

The system will now permit:

 Individuals to revise their payment due dates and/or amounts on existing

agreements.
 Individuals to revise existing extensions to regular installment agreements
and direct debit installment agreements.
 Individuals to revise existing regular installment agreements to a payroll
deduction installment agreement or a direct debit installment agreement.

Practitioners with valid authorizations to use the signature date found on their approved
Form 2848, Power of Attorney and Declaration of Representative, or the caller ID as an
alternate way to authenticate when requesting agreements for clients.

More than 75 percent of those eligible for an installment agreement can establish one
using the online application, according to the IRS. Since launching in October 2006,
more than 30,000 taxpayers have successfully used it to set up a payment agreement.
Eligible taxpayers who owe $25,000 or less in combined tax, penalties and interest can
self-qualify, apply and receive immediate notification of approval for installment

44
agreements – including pre-assessed agreements on tax year 2008 Form 1040
liabilities and paperless direct debit agreements.

NOTE: For security purposes, you will automatically be logged out of OPA
after 20 minutes of inactivity per page. Be sure to gather all the necessary
information so that you are not automatically logged out of OPA before
completing the required information. If you have difficulty entering the data
required, please call the IRS at the number listed under “When should I
call the toll-free number. “

http://www.irs.gov/individuals/article/0,,id=149373,00.html

Guaranteed Availability of Installment Agreements

7.60 The Internal Revenue Service Restructuring and Reform Act of 1998 requires the
Secretary to grant an installment agreement, at the taxpayer's option, if:

• the liability is $10,000, or less (excluding penalties and interest);

• within the previous 5 years, the taxpayer has not failed to file or to pay, nor
entered an installment agreement under this provision;

• if requested by the Secretary, the taxpayer submits financial statements, and the
Secretary determines that the taxpayer is unable to pay the tax due in full;

• the installment agreement provides for full payment of the liability within 3 years;
and

• the taxpayer agrees to continue to comply with the tax laws and the terms of the
agreement for the period (up to 3 years) that the agreement is in place.[Act §
3467; IRC § 6159)

<$25,000 Liabilities
7.70 The IRS has chosen to create a more liberal system that allows installment
agreements of up to 5 years for balances of less than $25,000.

Form 433A
7.80 In January, 2008 the IRS issued a revised Form 433A. The form requires that
those taxpayers who are employed to complete only the first 4 pages while self
employed individuals must complete 2 additional pages. It also provides a more logical
concise presentation of the taxpayer’s assets.

New more Onerous Allowable Expense Standards

7.90 In October, 2007 the IRS the IRS revised its allowable expense standards to
make them more onerous. In March, 2009 the IRS again revised the standards. Instead
of establishing national standards which recognized the need for higher living expense
for higher income families it began a system of one size fits all. It continued to fail to
recognize the varying cost of living in different regions and communities and eliminated

45
differentials for Hawaii and Alaska. It also added a new category of expenses for out-of-
pocket health care expenses.
Total allowable expenses include those expenses that meet the necessary expense
test. The necessary expense test is defined as expenses that are necessary to provide
for a taxpayer's and his or her family's health and welfare and/or production of income.
The expenses must be reasonable. The total necessary expenses establish the
minimum a taxpayer and family needs to live.

There are four types of necessary expenses:

• National Standards
• Out-of-Pocket Health Care
• Local Standards
• Other Expenses

National Standards: These establish standards for reasonable amounts for five
necessary expenses. Four of them come from the Bureau of Labor Statistics (BLS)
Consumer Expenditure Survey: food, housekeeping supplies, apparel and services,
and personal care products and services. The fifth category, miscellaneous, is a
discretionary amount established by the Service. It is $87 for one person up to $235
for 4 persons. The IRS allows a total of $262 per month for each member of the
household above 4.

Note: All five standards are included in one total national standard expense.

Out-of-Pocket Health Care Expenses: Out-of-pocket health care expenses include

medical services, prescription drugs, and medical supplies (e.g. eyeglasses, contact
lenses, etc.). Elective procedures such as plastic surgery or elective dental work are
generally not allowed. Taxpayers and their dependents are allowed the standard
amount monthly on a per person basis, without questioning the amounts they
actually spend. If the amount claimed is more than the total allowed by the health
care standards, the taxpayer must provide documentation to substantiate those
expenses are necessary living expenses. Generally, the number of persons allowed
should be the same as those allowed as exemptions on the taxpayer’s most recent
year income tax return. The out-of-pocket health care standard amount is allowed in
addition to the amount taxpayers pay for health insurance.

Local Standards: These establish standards for two necessary expenses: housing
and transportation. Taxpayers will be allowed the local standard or the amount
actually paid, whichever is less.

A. Housing - Standards are established for each county within a state.

When deciding if a deviation is appropriate, consider the cost of moving to a new
residence; the increased cost of transportation to work and school that will result
from moving to lower-cost housing and the tax consequences. The tax
consequence is the difference between the benefit the taxpayer currently derives
from the interest and property tax deductions on Schedule A to the benefit the
taxpayer would derive without the same or adjusted expense. Housing costs

46
include rent and/or house payments, taxes, repairs and utilities the IRM provides
as follows:

The utilities include gas, electricity, water, fuel, oil, bottled gas, trash
and garbage collection, wood and other fuels, septic cleaning, and
telephone. Housing expenses include: mortgage or rent, property
taxes, interest, parking, necessary maintenance and repair,
homeowner's or renter's insurance, homeowner dues and
condominium fees. Usually, this is considered necessary only for the
place of residence. Any other housing expenses should be allowed
only if, based on a taxpayer's individual facts and circumstances,
disallowance will cause the taxpayer economic hardship. [ IRM
5.15.1.9

B. Transportation - The transportation standards consist of nationwide

figures for loan or lease payments referred to as ownership cost, and additional
amounts for operating costs broken down by Census Region and Metropolitan
Statistical Area. Operating costs were derived from BLS data. If a taxpayer has a
car payment, the allowable ownership cost added to the allowable operating cost
equals the allowable transportation expense. If a taxpayer has no car payment
only the operating cost portion of the transportation standard is used to figure the
allowable transportation expense. Under ownership costs, separate caps are
provided for the first car and second car. If the taxpayer does not own a car a
standard public transportation amount is allowed.

Vehicle insurance, vehicle payment (lease or purchase),

maintenance, fuel, state and local registration, required inspection,
parking fees, tolls, driver's license, public transportation.
Transportation costs not required to produce income or ensure the
health and welfare of the family are not considered necessary.
Consider availability of public transportation if car payments
(purchase or lease) will prevent the tax liability from being paid in part
or full. Public transportation costs could be an option if it does not
significantly increase commuting time and inconvenience the
taxpayer.

Note: If the taxpayer has no car payment, or no car,

question how the taxpayer travels to and from work, grocer,
medical care, etc. The taxpayer is only allowed the operating
cost or the cost of transportation. [ IRM 5.15.1.9 ]

C. Other Expenses. Other expenses may be considered if they meet

the necessary expense test - they must provide for the health and welfare of the
taxpayer and/or his or her family or they must be for the production of income.
This is determined based on the facts and circumstances of each case. If other
expenses are determined to be necessary and, therefore allowable, document
the reasons for the decision in your history.

47
D. Conditional expenses. These expenses do not meet the necessary
expenses test. However, they are allowable if the tax liability, including projected
accruals, can be fully paid within five years.

E. National and local expense standards are guidelines. If it is

determined a standard amount is inadequate to provide for a specific taxpayer's
basic living expenses, allow a deviation. Require the taxpayer to provide
reasonable substantiation and document the case file.

F. Generally, the total number of persons allowed for national standard

expenses should be the same as those allowed as dependents on the taxpayer's
current year income tax return. Verify exemptions claimed on taxpayer's income
tax return meet the dependency requirements of the IRC. There may be
reasonable exceptions. Fully document the reasons for any exceptions. For
example, foster children or children for whom adoption is pending.

G. A deviation from the local standard is not allowed merely because it

is inconvenient for the taxpayer to dispose of valued assets.

H. Length. Revenue officers should consider the length of the

payments. Although it may be appropriate to allow for payments made on the
secured debts that meet the necessary expense test, if the debt will be fully
repaid in one year only allow those payments for one year. [ IRM 5.15.1.7 ]

Five Year Test

7.100 The amount allowed for necessary or conditional expenses depends on the
taxpayer's ability to full pay the liability within five years and on the taxpayer's individual
facts and circumstances. If the liability can be paid within 5 years, it may be appropriate
to allow the taxpayer the excessive necessary and conditional expenses. If the taxpayer
cannot pay within 5 years, it may be appropriate to allow the taxpayer the excessive
necessary and conditional expenses for up to one year in order to modify or eliminate
the expense. (See IRM 5.14, Installment Agreements) [ IRM 5.15.1.10 ]

8. OFFER IN COMPROMISE

Number of Offers
8.10 The total number of proposed offer has halved from 128,000 in FY 2001 to
46,000 in FY 2007. The number of OICs accepted declined from 38,643 (or 34 percent)
in FY 2001, 12,000 in FY 2007 (or 24%) and 10,000 in 2008 (or 24%). The IRS has
made it so difficult to secure an offer in compromise that many taxpayers and their
representative no longer choose to propose a compromise.

48
OIC’s FY2000 to 2008
8.20 In February, 2007 the IRS issued new offer in compromise forms which apply the
provisions of TIPRA 2005 discussed below. Taxpayers proposing compromises based
upon doubt as to collectibility of effective tax administration must submit revised Form
656. Taxpayers proposing an offer based upon doubt as to liability must now submit
Form 656-L and a narrative setting forth defenses to the liability. To comply with the
new downpayment requirements taxpayers must submit Form 656-PPV with the
required downpayment.

Tax Increase Prevention and Reconciliation Act of 2005

8.30 The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), section
509, made major changes to the IRS OIC program. These changes affect all offers
received by the IRS on or after July 16, 2006..TIPRA section 509 amends IRC section
7122 by adding a new subsection (c) “Rules for Submission of Offers-in-Compromise.”

Payments With Offers

8.35 A taxpayer filing a lump-sum offer must pay 20% of the offer amount with the
application (IRC 7122(c)(1)(A)). A lump-sum offer means any offer of payments made in
five or fewer installments.

A taxpayer filing a periodic-payment offer must pay the first proposed installment
payment with the application and pay additional installments while the IRS is evaluating
the offer (IRC section 7122(c)(1)(B)). A periodic-payment offer means any offer of
payments made in six or more installments.

Failure to Make Deposit

8.40 Taxpayers can avoid delays in processing their OIC applications by making all
required payments in full and on time. Failure to pay the 20 percent on a lump-sum
offer, or the first installment payment on a periodic-payment offer, will result in the IRS
returning the offer to the taxpayer as nonprocessable (IRC section 7122(d)(3)(C) as
amended by TIPRA).

49
Not Refundable
8.50 The 20 percent payment for a lump-sum offer and the installment payments on a
periodic-payment offer are “payments on tax” and are not refundable deposits (IRC
section 7809(b) and Treasury Regulation 301.7122-1(h)).

Taxpayer Advocate Research

8.60 In 2007, the Taxpayer Advocate Service conducted a research study to assess the
impact of the down payment requirement.28. The study analyzed a representative
sample of more than 400 offers that the IRS accepted in the months just before the 20
percent requirement took effect. Among the principal findings were that 56 percent of
taxpayers whose offers were accepted and who made lump-sum payments obtained the
funds from family members and friends. While family and friends may be willing to help
a taxpayer get straight with the IRS, they are probably much less willing to provide
funds for taxpayers to make down payments on offers that are unlikely to be accepted –
and fewer than one in four offers is, in fact, accepted. Thus, not surprisingly, the
number of offers received by the IRS fell by 21 percent from FY 2006 to FY 2007 as the
down payment requirement took effect.

Failure to Make Installment Payments

8.70 Taxpayers failing to make installment payments on periodic-payment offers after
providing the initial payment will cause the IRS to treat the offer as a withdrawal. The
IRS will return the offer application to the taxpayer (IRC section 7122(c)(1)(B)(ii)).A
lump-sum offer accompanied by a payment that is below the required 20 percent
threshold will be deemed processable. However, the taxpayer will be asked to pay the
remaining balance in order to avoid having the offer returned. Failure to submit the
remaining balance will cause the IRS to return the offer and retain the $150 application
fee.

Taxpayers filing periodic-payment offers must submit the full amount of their first
installment payment in order to meet the processability criteria. Otherwise, the IRS will
deem the offer as unprocessable and will return the application to the taxpayer along
with the $150 fee.

Low Income Taxpayers

8.80 Under the new law, taxpayers qualifying as low-income or filing an offer solely
based on doubt as to liability qualify for a waiver of the new partial payment
requirements. Taxpayers qualifying for the low-income exemption or filing a doubt-as-to-
liability offer only are not liable for paying the application fee, or the payments imposed
by TIPRA section 509. A taxpayer seeking a waiver must submit Form 656-A with the
offer. The monthly income levels to qualify are listed below:

50
Deemed Accepted
8.90 The IRS will deem an OIC “accepted” that is not withdrawn, returned, or rejected
within 24 months after IRS receipt. When calculating the 24-month timeframe, the IRS
will disregard any time periods during which a liability included in the OIC is the subject
of a dispute in any judicial proceeding (IRC section 7122(f) as amended by TIPRA). In
five years the consideration period for deemed acceptance will become 12 months.

Background
8.100 An offer in compromise is a settlement of a delinquent tax account for less than
the full amount due. Sec. 7122 states that the IRS may compromise any civil or criminal
case arising under the Internal Revenue Laws prior to reference to the Department of
Justice for prosecution or defense. In the past very few offers were accepted because
the standards were almost impossible to meet and the IRS really did not encourage
them. But in 1992, the IRS decided that they had a major problem with accounts
receivable inventory and a growing number of cases reported as currently not
collectible. The new policy espoused by the IRS was that they would accept an OIC
when it was unlikely that the tax liability could be collected in full and the amount offered
reasonably reflected collection potential.

Supporting Documents
8.110 The financial statements require the proponent to supply documentation for each
item on the forms, i.e. pay stubs, car payment book, mortgages, pay stubs, charge
account statements, and bank statements. The IRS considers smaller liability offers
without conducting a field investigation, therefore it is requiring the proponent to supply
all the info to make a decision without field verification.

$150 Processing Fee

8.120 The Internal Revenue Service now charges a $150 application fee for the
processing of offers in compromise. The IRS expects that this fee will help offset the
cost of providing this service, as well as reduce frivolous claims. The law authorizes
federal agencies to charge fees to defray the costs of providing certain services.
Guidelines encourage such fees for benefits beyond those provided to the general
public. The IRS anticipates the fee also will reduce the number of offers that are filed
inappropriately — for example, solely to delay collection — enabling the agency to
redirect resources to the processing of acceptable offers. Offers based solely on
hardship may seek a fee waiver.

51
Determining Processability
8.130 The IRS campuses do an intensive review of each offer to determine if it is
processable. The author believes that the IRS makes a concerted effort to return most
offers to avoid the effort of performing a substantive consideration. An offer in
compromise will be deemed not processable if one or more of the following criteria are
present:

A. Taxpayer Not in Compliance - All tax returns for which the taxpayer
has a filing requirement must be filed. This rule applies even if a Service
employee previously decided not to pursue the filing of the return under the
provisions of Policy Statement P-5-133, because it was believed to have "little or
no tax due" . In-business taxpayers must have timely deposited, filed and paid all
required employment tax returns for the two (2) preceding quarters prior to filing
the offer, and must be current with federal tax deposits for the quarter in which
the offer was submitted.

Note: Generally speaking, IRM 5.1.11.1.3(2) only requires

employees to conduct a compliance check, confirm and
document all tax periods were filed for the preceding 6 year
period. The only exception would be if fraud were discovered
during the course of the investigation. Even then it should be
extremely rare to go beyond 6 years. IRM 5.1.11.4 discusses
enforcement criteria, which states that if the taxpayer refuses
to file, neglects to file, or indicates an inability to file, then the
employees should determine to what extent enforcement
should be used (e.g. summons, 6020(b), referral to Exam, or
field, etc.). Filing requirements will normally be enforced for a
6 year period, which is calculated by starting with the tax year
that is currently due, and going back 6 years.

B. Taxpayer in Bankruptcy - An offer will not be considered during a

bankruptcy proceeding.

Note: IRM 25.17.4.7, Offers-in-Compromise and Bankruptcy

(07-01-2002), states that "[t]oo many administrative and legal
problems would be created if a tax liability was simultaneously
the subject of a court-supervised bankruptcy case and the
administrative offer-in-compromise process." Therefore, it is
the policy of IRS that an offer will not be considered if a
taxpayer is in bankruptcy.

C. Taxpayer did not submit the offer on the current revision of

Form 656 - The offer must be submitted on the most current revision of the Offer
in Compromise Form 656.

D. Taxpayer did not submit the most current revision of Forms 433-
A and/or 433-B - The most current revision of the Collection Information
Statement Forms 433-A and/or 433-B must be submitted with the offer.

52
E. Taxpayer did not submit the application fee with the offer - The
application fee of $150 or the signed Form 656-A, Income Certification for Offer
in Compromise Application Fee, must be submitted with each Form 656 (Form
656-A applies to individual taxpayers only).

Note: The application fee is not required if the offer is filed

solely on the basis of Doubt as to Liability.

An offer cannot be returned for the sole reason that the cost of an investigation may
exceed the amount offered. [IRM 5.8.3.4.1]

Full Pay Processing

8.140 The IRS is always looking for where it believes the taxpayer has the ability to full
pay the liability. Its manual provides as follows:

Taxpayers may submit an offer to compromise the liabilities based on

Doubt as to Collectibility, yet indicate on their application an ability to pay
the account in full. These cases, once determined to be processable, will
be screened out. Absent any special circumstances they will be rejected
with no further investigation or verification. The taxpayer will be directed
toward the appropriate resolution for the delinquency. The rejection letter
will be the first communication with the taxpayer. A decision to reject with
appeals rights is adequately justified by the taxpayer's self-disclosed
ability to pay in full.

Initial Review
8.150 For processable offers one of the first considerations is to determine if the
taxpayer can pay in full. The following initial review should be conducted on all
processable offers to make that determination.

• Complete the Full Pay worksheet using the taxpayer's figures only, as
reflected on the CIS.

• Do not adjust any asset values or apply necessary expense standards.

[IRM 5.8.3.12]

Computation of Offer Amount

8.160 The IRS uses three different methods for determining the adequacy of an offer
depending on the period of time the taxpayer proposes for payment of the offer amount.
The methods are:

• Cash (paid in 90 days or less), or

• Short-Term Deferred Payment (more than 90 days, up to 24 months), or

• Deferred Payment (offers with payment terms over the remaining statutory
period for collecting the tax.).

53
 NOTE: In all three cases, the IRS will release any filed Notice of Federal
Tax Lien once you have fully paid the offer amount and any interest that
has accrued.

Cash Offer
8.170 You must pay cash offers within 90 days of acceptance. You should offer the
realizable value of your assets (quick sale value) plus the total amount the IRS could
collect over forty-eight months of payments represent value of income). When the ten-
year statutory period for collection expires in less than forty-eight months, you must use
the Deferred Payment Chart shown in the instructions to Form 656. The Internal
Revenue Service's method of determining the adequacy of an offer could be best
expressed by:

Quick Sale Value Plus Present Value of Income Equals Offer In

Compromise (QSV + PVI = OIC)

In applying this formula, the IRS determines the Quick Sale Value of all of the client's
assets and then adds the amount of the present value of the taxpayer's ability to pay. It
aggregates the two numbers to arrive at an Offer in Compromise amount. The following
paragraphs will discuss the Internal Revenue Service's methodology for determining
quick sale value and the present value of income.

Short-Term Deferred Payment Offer

8.180 This payment option requires you to pay the offer within two years of acceptance.
The offer must include the realizable value of your assets in addition to the total amount
the IRS could secure over sixty months (or the remainder of the ten-year statutory
period for collection, whichever is less) through monthly payments. The IRS may file a
Notice of Federal Tax Lien on tax liabilities compromised under short-term payment
offers.

Deferred Payment Offers

8.190 This payment option requires you to pay the offer amount within the remaining
statutory period for collecting the tax. The offer must include the realizable value of
your assets plus the amount the IRS could collect through monthly payments during the
remaining life of the collection statute. The deferred payment option itself has three
payment options:

Option One is: Full payment of the realizable value of your assets within
90 days from the date the IRS accepts your offer and Your future income
in monthly payments during the remaining life of the collection statute;

Option Two is: Cash payment for a portion of the realizable value of your
assets within 90 days from the date the IRS accepts your offer and
Monthly payments during the remaining life of the collection statute for
both the balance of the realizable value and your future income;

Option Three is: The entire offer amount in monthly payments over the
life of the collection statute. As with short-term deferred payment offers,
the IRS may file a Notice of Federal Tax Lien.
54
Corporate Trust Fund Liabilities
8.200 The IRS has. recently changed its rules with respect to in business offers in
compromise. It now requires that each potentially responsible officer of the company
sign an agreement to assessment of the trust fund recovery penalty in advance of
consideration of any corporate or LLC offer. The new system is extremely unfair
because the IRS is requiring even those who should not be held liable for the TFRP to
agree to liability and assessment. Only after the liability has been assessed against a
non-responsible person may she file a claim for refund and defend against the penalty.
The system is extremely unfair and represents an attempt to deprive officers of their
statutory due process rights.

Pursuit of Officers After Compromise.

8.210 Under this new system the IRS could compromise with the corporate entity
based upon its ability to pay and then continue to pursue responsible officers for the
remaining trust fund liability. The owners and officers would face continuing economic
risk. The system also makes it impossible for a company that had a change in
leadership to propound an offer in compromise. Prior officers would probably refuse to
consent to the demands of the IRS that they waive their TFRP appeal rights thereby
negating any opportunity for the company to have its offer considered by the IRS.

Promote Effective Tax Administration

8.220 As part of the IRS Restructuring and Reform Act of 1998 (RRA 98), Congress
added section 7122(c) to the Internal Revenue Code. That section provides that the
Service shall set forth guidelines for determining when an offer in compromise should
be accepted. Congress explained that these guidelines should allow the Service to
consider:

• Hardship,
• Public policy, and
• Equity

Treasury Regulation 301.7122-1 authorizes the Service to consider offers raising these
issues. These offers are called Effective Tax Administration (ETA) offers.

Encourage Compliance
8.230 The availability of an Effective Tax Administration (ETA) offer encourages
taxpayers to comply with the tax laws because taxpayers will:

• Believe the laws are fair and equitable, and

• Gain confidence that the laws will be applied to everyone in the
same manner.

The Effective Tax Administration (ETA) offer allows for situations where tax liabilities

• The tax is legally owed, and

• The taxpayer has the ability to pay it in full

55
Only Available If There Is No Doubt As to Liability Or Collectibility
8.240 An Effective Tax Administration (ETA) offer can only be considered when the
Service has determined that the taxpayer does not qualify for consideration under Doubt
as to Liability (DATL) and/or Doubt as to Collectibility (DATC). The taxpayer must
include the Collection Information Statement (Form 433-A and/or Form 433-B) when
submitting an offer requesting consideration under Effective Tax Administration (ETA).
Economic hardship standard of § 301.6343-1 specifically applies only to individuals.
[IRM 5.8.11.1]

Rules for Evaluating Offers to Promote Effective Tax Administration

8.250 The determination to accept or reject an offer to compromise made on the
ground that acceptance would promote effective tax administration within the meaning
of this section will be based upon consideration of all the facts and circumstances,
including the taxpayer's record of overall compliance with the tax laws.

Factors
8.260 Factors supporting (but not conclusive of) a determination of economic hardship
include:

• Taxpayer is incapable of earning a living because of a long term illness,

medical condition, or disability and it is reasonably foreseeable that taxpayer's
financial resources will be exhausted providing for care and support during the
course of the condition;

• Although taxpayer has certain assets, liquidation of those assets to pay

outstanding tax liabilities would render the taxpayer unable to meet basic living
expenses; and

• Although taxpayer has certain assets, the taxpayer is unable to borrow

against the equity in those assets and disposition by seizure or sale of the assets
would have sufficient adverse consequences such that enforced collection is
unlikely Temp Reg 301.7122-1T(b)(4)(iv)(B)]

Undermine Compliance
8.270 Factors supporting (but not conclusive of) a determination that compromise
would not undermine compliance by taxpayers with the tax laws include:

• Taxpayer does not have a history of noncompliance with the

filing and payment requirements of the Internal Revenue Code;

• Taxpayer has not taken deliberate actions to avoid the

payment of taxes; and

• Taxpayer has not encouraged others to refuse to comply

with the tax laws.[Temp Reg. 301.7122-1T(b)(4)(iv)(C)]

Exceptional Circumstances

56
8.280 The following examples illustrate cases where exceptional circumstances exist
such that collection of the full liability will be detrimental to voluntary compliance by
taxpayers; and compromise of the liability would not undermine compliance by
taxpayers with the tax laws.

57
EXHIBITS
59
60
61
62
63
64
65
 National Standards: Food, Clothing and Other Items
Expense One Two Three Four
Person Persons Persons Persons

Food $285 $537 $626 $752

Housekeeping supplies $28 $66 $61 $74

Apparel & services $86 $162 $209 $244

Personal care products & services $31 $55 $59 $65

Miscellaneous $87 $165 $197 $235

Total $517 $985 $1,152 $1,370

More than four persons Additional Persons

Amount

For each additional person, add to four-person total $262

allowance:

National Standards: Out-of-Pocket Health Care

The table for health care expenses, based on Medical Expenditure Panel Survey data,
has been established for minimum allowances for out-of-pocket health care expenses.
Out-of-pocket health care expenses include medical services, prescription drugs, and
medical supplies (e.g. eyeglasses, contact lenses, etc.). Elective procedures such as
plastic surgery or elective dental work are generally not allowed.
Taxpayers and their dependents are allowed the standard amount monthly on a per
person basis, without questioning the amounts they actually spend. If the amount
claimed is more than the total allowed by the health care standards, the taxpayer must
provide documentation to substantiate those expenses are necessary living expenses.
The out-of-pocket health care standard amount is allowed in addition to the amount
taxpayers pay for health insurance.
Out-of-Pocket Costs
Under 65 $60
65 and Older $144

66
Public Transportation
Public Transportation

National $173

Ownership Costs

One Car Two Cars

National $489 $978

Operating Costs

Metropolitan Area One Car Two Cars

Northeast Region $235 $470

Boston $225 $450

New York $280 $560

Philadelphia $235 $470

Midwest Region $183 $366

Chicago $217 $434

Cleveland $186 $372

Detroit $267 $534

Minneapolis-St. Paul $187 $374

South Region $201 $402

Atlanta $226 $452

Baltimore $217 $434

Dallas-Ft. Worth $228 $456

Houston $263 $526

Miami $275 $550

67
 Metropolitan Area One Car Two Cars

Washington, D.C. $230 $460

West Region $211 $422

Los Angeles $261 $522

Phoenix $232 $464

San Diego $244 $488

San Francisco $261 $522

Seattle $192 $384

The data for the Operating Costs section of the Transportation Standards are provided
by Census Region and Metropolitan Statistical Area (MSA). The following table lists the
states that comprise each Census Region. Once the taxpayer’s Census Region has
been ascertained, to determine if an MSA standard is applicable, use the definitions
below to see if the taxpayer lives within an MSA (MSAs are defined by county and city,
where applicable). If the taxpayer does not reside in an MSA, use the regional standard.

California

Maximum Monthly Allowance

68
 Housing and
Housing and Housing and Housing and Housing and
Utilities for a
County Utilities for a Utilities for a Utilities for a Utilities for a
Family of 5 or
Family of 1 Family of 2 Family of 3 Family of 4
more

Alameda 1,920 2,255 2,376 2,650 2,692

Alpine 1,390 1,632 1,720 1,918 1,949

Amador 1,304 1,532 1,614 1,800 1,829

Butte 1,162 1,365 1,438 1,604 1,629

Calaveras 1,295 1,521 1,603 1,787 1,816

Colusa 1,079 1,267 1,335 1,488 1,512

Contra
1,890 2,220 2,339 2,608 2,650
Costa

Del Norte 1,127 1,324 1,395 1,555 1,580

El Dorado 1,618 1,900 2,002 2,232 2,268

Fresno 1,208 1,419 1,496 1,668 1,695

Glenn 991 1,164 1,226 1,367 1,390

Humboldt 1,139 1,338 1,410 1,572 1,598

Imperial 1,187 1,394 1,469 1,638 1,664

Inyo 1,261 1,481 1,561 1,740 1,768

Kern 1,146 1,345 1,418 1,581 1,606

Kings 1,138 1,337 1,409 1,571 1,596

Lake 1,133 1,331 1,402 1,564 1,589

Lassen 1,121 1,316 1,387 1,547 1,572

Los
1,769 2,077 2,189 2,441 2,480
Angeles

Madera 1,153 1,354 1,427 1,591 1,616

Marin 2,542 2,985 3,146 3,508 3,564

Mariposa 1,165 1,368 1,442 1,608 1,634

Mendocin
1,292 1,517 1,599 1,783 1,812
o

Merced 1,176 1,382 1,456 1,623 1,650

Modoc 819 962 1,013 1,130 1,148

Mono 1,636 1,922 2,025 2,258 2,294

Monterey 1,687 1,981 2,088 2,328 2,365

Napa 1,714 2,013 2,121 2,365 2,404

Nevada 1,498 1,760 1,854 2,067 2,101

Orange 1,976 2,321 2,446 2,727 2,771

Placer 1,697 1,993 2,100 2,342 2,380

Plumas 1,161 1,364 1,437 1,602 1,628

Riverside 1,493 1,754 1,848 2,060 2,094

69
Sacramen
1,390 1,632 1,720 1,918 1,949
to
70
 Portions Reprinted from

"REPRESENTING THE AUDITED TAXPAYER BEFORE THE IRS"

AND

REPRESENTATION BEFORE THE COLLECTION DIVISION OF

THE IRS

by

Robert E. McKenzie

WITH PERMISSION FROM

THOMSON WEST
Rochester, NY

All Rights Reserved

COPYRIGHT 2009