Attorneys Audit Technique Guide - Chapter 2
NOTE: This document is not an official pronouncement of the law or the position of the Service and cannot be used, cited, or relied upon as such. This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.
Chapter 2 - Audit Steps
- Pre-Contact Analysis
- Information Document Requests
- Initial Interview
- Exhibit 2-1, Sample Information Document Request (IDR)
- Exhibit 2-2 Bank Document Request List
- Exhibit 2-3 Interview
A comprehensive pre-contact analysis is essential in performing an effective audit. Refer to IRM 4.10.2, “Examination of Returns- Pre-Contact Responsibilities,” for more information. Given the nature of the cases being audited and the myriad of possible issues, a thorough search of available data is necessary. Some information resources examiners should consider include licensing records maintained by the appropriate state bar association or licensing agency and Internet searches using the attorney’s or firm’s name. Both asset searches and income searches are discussed in this section.
Examiners have access to Accurint which provides information on a person, their business, their professional standing, their assets, pending or resolved litigation, and other matters. The following is a discussion of pre audit information available on Accurint and a summary of what databases should be reviewed during the pre audit stage. For more detailed information, examiners should refer to the Accurint User’s Guide, which is available to IRS personnel on the IRS Intranet site.
A people search in Accurint will provide address information, telephone numbers and employment information (listed as people at work). This information can be used to verify the size and location of an attorney’s offices.
An Accurint asset search can provide information on motor vehicles, property assessments, property deeds, watercraft and aircraft. Asset searches may also disclose property ownership, purchases, and sales information that would not appear on a taxpayer’s return that may be discussed during the initial interview. While useful, care should be taken reviewing the search results to eliminate duplicate entries. Care should be taken to review parcel numbers, registration numbers, and other identifying information to eliminate duplicate information. An Accurint search of the specific assets should be performed for identified assets. The Federal Aviation Agency (FAA) Internet site also provides searchable information on aircraft assets.
Accurint searches can provide information about business entities, such as the business or taxpayer name, corporate filings, UCC filings, fictitious names (doing business as or “dba” names), and Experian business information.
Accurint searches can provide information on what licenses the taxpayer may possess, such as a driver’s license, FAA license, law licenses and other professional licenses.
Court files are another useful source of information. These files can provide information regarding marriage and divorce actions, bankruptcies, foreclosures, liens, judgments, and lawsuits. The court records on these legal actions, if available, may provide details of assets and other useful information warranting a trip to the Court where the records are held.
A thorough search of the Internet should be completed prior to the initial interview. Searches should be completed using the taxpayer’s name, firm name, and area of expertise. Relevant websites found identifying the taxpayer should be printed and included in the case file for later reference, if necessary.
A search using the state bar association should be completed. This search may disclose relevant information, such as licensing information, area of expertise, advertising, education, press releases, pro-bono work, professional associations and affiliations, and referral services. As discussed later, identifying an attorney’s area(s) of expertise is important because this may have an impact on various income and expense issues.
Another source of information available online is the Martindale Hubbel Directory . This is a national directory of attorneys, which provides information on an attorney’s educational background, the year they were admitted to practice, any listed areas of expertise, and also a “peer review” rating.
Other Income Related Searches
Income information is available from a variety of sources, some of which are discussed here.
The Federal Government has imposed certain cash reporting requirements in recent years. These reporting requirements were established to help monitor and track large cash flows. Several forms are of interest to revenue agents are available from Web CBRS. These forms may be summarized on an IRP report.
The first form, FinCEN Form 104, Currency Transaction Report (CTR), is used to report cash transactions (deposits and withdrawals) greater than $10,000 involving various financial institutions. These financial institutions, including banks, savings and loans, credit unions and other non-bank financial institutions such as check cashers, and wire transfer companies file the Form 104. The Form 104 identifies the individual making the transaction, the person or organization for whom the transaction was conducted, the financial institution involved in the transaction, and the amount of money involved.
The second form, FinCEN Form 105, Report of International Transportation of Currency and Monetary Instruments (CMIR), is used to report the international transportation of currency or monetary instruments that in aggregate exceed $10,000. Individuals must file a FinCEN Form 105 whenever they carry more than $10,000 in cash and/or monetary instruments into or out of the United States. Also, individuals who physically send or receive (typically through the mail) more than $10,000 in cash and/or monetary instruments must file a FinCEN Form 105.
The third form, IRS-FinCEN Treasury Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business, is a report of cash payments over $10,000 (U.S. dollars or foreign currency equivalent) received in a trade or business. This form is filed by the business receiving funds and is filed by retailers or businesses selling large ticket items, bulk inventory, and luxury goods. It identifies the customer, provides a description of the transaction and goods, and also lists the method of payment.
The fourth form, FinCEN Form 103, Currency Transaction Report by Casinos (CTR-C), is used by casinos to report cash transactions (either cash received or cash disbursed) that exceed in the aggregate $10,000 in one gaming day. This form lists the individual or organization involved, details of the transaction, and the reporting entity.
The fifth form, Treasury Form TDF 90-22.1, the Report of Foreign Bank and Financial Accounts (FBAR), is required of all entities, including individuals, having a financial interest in or signature authority over foreign bank and financial accounts with an aggregate value of more than $10,000.
Printouts of any transactions reported and processed at the Enterprise Computing Center in Detroit are generally included in the case building material or may be obtained from the Web CBRS query system. The CBRS system servers are located in Martinsburg Computing Center. Every POD should have someone trained to access the CBRS query system and retrieve data from Web CBRS in printed or electronic formats.
Any attorney may receive cash in the course of their business activities. However, some attorneys are less likely to receive cash payments than others. For example, attorneys that are compensated through third party payments (i.e., insurance settlements) are less likely to receive currency.
Certain attorneys that are more likely to be paid directly by the client include:
- Criminal defense attorneys;
- Estate and trust attorneys;
- Real estate attorneys; and,
- Tax attorneys
Attorneys are subject to the reporting requirements for Form 8300. Some attorneys may raise an attorney-client privilege defense for not filing Forms 8300 to report payments in cash. This is another factor to consider in support of referring the case for a Form 8300 examination.
The Return Preparer Coordinators maintain lists detailing all of the tax returns that were completed by a particular preparer. These are useful when an attorney performs tax services for clients. This information may be useful in identifying sources of income, return preparation trends, and the taxpayer’s clients.
The list of Return Preparer Coordinators can be accessed from the SB/SE Examination website.
IRP transcripts provide information about payments a taxpayer receives that are reported to the IRS. For example, these transcripts provide information about reported Forms 1099, CBRS report summaries, Social Security payments, rental income, property sales, and interest and dividend payments. IRP transcripts may provide information about previously unknown payments or bank accounts. Both Social Security and Employer Identification Numbers need to be requested for a complete report.
It is important to perform a comparative analysis of at least 3 years during the pre-audit planning phase. This step is necessary to determine if there are any unusual changes in income, expenses and taxes paid before initiating an examination.
A sample IDR that may be utilized is included as Exhibit 2-1. This sample should be modified as necessary to address the unique issues for a particular audit.
A list of suggested items to request in a bank summons is included as Exhibit 2-2.
The initial interview is, perhaps, the most important step of the audit process. If possible, it is important to discuss examination issues with the taxpayer. A representative may not know enough about the attorney’s practice to provide detailed answers. Also, it is important to determine the attorney’s responsibility for financial transactions.
Careful planning and preparation for the taxpayer interview will help ensure that the taxpayer provides relevant information. The tax return, pre-contact information in the case file, Accurint reports, bar association information, other Internet searches, and industry related issues should be carefully considered.
A sample initial interview outline is included as Exhibit 2-3. This sample outline should be modified and expanded upon to address issues identified during the pre-contact analysis. During the interview, be sure to ask follow-up questions based on the taxpayer's responses.
Questions about how the practice started and areas of specialization will give insights into probable accounting systems, the size and scope of the taxpayer's practice, and what types of income and operating costs to expect. Information on specialized accounting software, if used in the attorney’s practice, may be available through Internet research.
An effective income probe is crucial since unreported income may become an issue as the examination progresses. All possible income sources need to be identified. Some questions to ask are:
- How much cash was on hand at beginning and end of year?
- Were any loan proceeds received?
- Were referral fees received from other attorneys?
- Was compensation received in forms other than cash? Define bartering and use examples such as property interests, services, other assets received from a client in lieu of normal compensation.
- Are there any foreign accounts or offshore interests?
- Are there any interests in other entities?
- What Internet sites are maintained by the taxpayer?
- On-line income sources including consulting, on-line bartering?.
- Other on-line services provided?
A thorough understanding of the taxpayer's bookkeeping system and internal controls is necessary. Have the attorney or the bookkeeper walk through the recordation process from the point where the attorney is retained by a client to the settlement of the account. Clearly determine and document the taxpayer's level of involvement in bookkeeping, check writing, and trust account activity. Generally, an attorney handles the trust accounts personally, but other duties may be delegated. Trust account issues are discussed in a later section of this document. If the taxpayer is not involved in the bookkeeping, find out who is and arrange to speak with that person. Be sure to obtain all required authorizations to do so from a responsible party of the taxpayer.
Accounting systems vary widely depending on the types of transactions conducted and the types of law practiced. For example, personal injury attorneys seldom receive any fee until a case is resolved, and the fee collected is usually a percentage of the awarded amount. They often advance client costs related to the litigation, such as court costs. Question the treatment of these expenses on the books and the tax return. This issue is discussed in a later section. Criminal defense attorneys usually arrange for clients to pay their own court costs. They are sometimes paid in cash and sometimes receive noncash compensation such as an entity interest, bartering or other assets.
Ask for the bank records for all accounts including any investment accounts.
Records for trust account(s) should also be requested with the initial IDR. Question the taxpayer about the use of each account. Depending on the size of the practice and the sophistication of the recordkeeping system, a number of different accounts may be used to pay expenses and deposit receipts. It is easier to ask the taxpayer to explain their accounting and recordkeeping system at the beginning and verify the information given than to try to understand these systems by reviewing bank records provided later.
At the conclusion of the initial interview, you should have an understanding of the taxpayer's accounting system, his or her level of involvement in that system, and also who to talk to about questions that arise during the audit. In addition, the taxpayer's level of credibility can be established through comparison of the pre-audit analysis and information supplied during the interview. This information will help determine the scope of the examination.
Please have the following records available at our appointment. These items are needed, but are not intended to be all inclusive; additional items may be required at a later time.
- All books and records: Cash receipts and disbursements journals, appointment book(s), client's card index, daily log or receipts book, journals of receipts and disbursements from trust funds, payroll journals, subsidiary ledgers, and chart of accounts
- Bank statements, cancelled checks, and deposit slips for all personal, business and trust accounts for the periods 1/__ through 1/__ . Bank reconciliation statements for the last month of the calendar year for all business and trust accounts.
- Investment records, account statements and other investment information
- Work papers used to prepare/reconcile books with the tax return
- Client listing for the year(s) under examination.
- Copies of Forms 1040 for 20__ and 20__ .
- Copies of Forms 8300 filed for the examination year.
- Employers quarterly tax returns--Federal and State (Forms 940, 941, and State Forms) for the year under examination to the present.
- Employee(s) Forms W-2 and W-4 for the year under examination and all Forms 1099 received and issued.
- Invoices covering all acquisitions and dispositions of capital assets during the examination year and verification of basis for the assets shown on the depreciation schedule.
- Records substantiating the claimed travel & entertainment expenses as required by IRC § 274--diary, itinerary, invoices, cancelled checks, names, dates, business purpose, etc.
- The following information regarding all open or closed checking (interest and non-interest bearing) and savings accounts:
- Signature cards
- Bank statements
- Cancelled checks - front & back
- Deposit tickets & items
- Credit and debit memos
- Wire transfer records
- Forms 1099 or back-up withholding statements.
- Retained copies of all open or closed bank loan or mortgage documents:
- Loan application
- Loan ledger sheet
- Copy of loan disbursement document
- Copy of loan repayment document
- Loan correspondence file
- Collateral agreements
- Copies of notes or other instruments reflecting the obligation to pay
- Copies of real estate mortgages, chattel mortgages, or other security for bank loans
- Copies of annual interest paid statements
- Copies of loan amortization statements
- Copies of any and all documents in loan package records.
- Certificates of deposit (purchased or redeemed):
- Copies of the certificates
- Records pertaining to interest earned, withdrawn or reinvested
- Forms 1099 or back-up withholding statements.
- Open or closed investment or security custodian accounts:
- Documents reflecting purchase of security
- Documents reflecting negotiation of security
- Safekeeping records and logs
- Receipts for the delivery of securities
- Copies of annual interest paid statements.
- All open or closed IRA, Keogh, and other retirement plans:
- Account statements
- Investment, transfer, and redemption confirmation slips
- Documents reflecting purchase of investment
- Documents reflecting redemption of investment
- Copies of annual interest earned statements.
- Customer correspondence file.
- Retained copies of all Cashier's, Manager's, Bank, or Traveler's checks and money orders.
- Wire transfer files:
- Fed wire, Swift, or other documents reflecting transfer of funds to, from, or on behalf of (the subject's name)
- Documents reflecting source of funds for wire out
- Documents reflecting disposition of wire transfer in.
- Retained copies of all open or closed safe deposit box rental and entry records.
- Open or closed credit card files
- Applications for credit cards
- Monthly statements
- Copies of charges
- Copies of documents used to make payments on account.
- Retained copies of Currency Transaction Reports
- Retained copies of bank's CTR Exempt List (if subject is exempt) and documents reflecting justification for exemption.
INITIAL INTERVIEW AND BUSINESS HISTORY
CURRENT BUSINESS PHONE NUMBER:
CURRENT PERSONAL PHONE NUMBER:
PRIOR AUDIT AND AUDIT ISSUES:
HOW DID BUSINESS START:
AREA(S) OF LEGAL SPECIALTY:
STATES LICENSED TO PRACTICE IN:
SPECIALTY COURTS ADMITTED TO PRACTICE BEFORE (for example, U.S. Tax Court):
GEOGRAPHIC AREA OF PRACTICE:
OTHER OFFICE LOCATIONS:
MANAGER IN CHARGE OF LOCATIONS:
HAVE YOU EVER FILED OR PLAN TO FILE FOR BANKRUPTCY:
HAVE ALL PAYROLL RETURNS BEEN FILED TO DATE:
WHO HANDLES PAYROLL RECORDS:
WHO PREPARES PAYROLL RETURNS, FORMS W-2s AND 1099s:
ARE 1099s ISSUED TO INDIVIDUALS FOR PAYMENTS OF $600 OR MORE:
WHEN DOES YOUR COMPANY SECURE SSNs:
HAVE YOU RECEIVED A NOTIFICATION LETTER FROM SERVICE CENTER REGARDING NO/INVALID SSN/EIN NUMBERS? IF YES, WHAT ACTION HAVE YOU TAKEN:
HOW DO YOU PAY YOURSELF:
METHOD OF OPERATION:
AVERAGE TIME BETWEEN BILLING & PAYMENT:
AVERAGE AMOUNT OF RETAINER RECEIVED:
DO YOU ADVANCE CLIENT COSTS:
AGREEMENT WITH CLIENTS RE ADVANCEMENT OF COSTS, (NET FEE OR GROSS FEE ARRANGEMENT). IF CASE IS LOST, DOES CLIENT REIMBURSE FOR EXPENSES:
DO YOU RECEIVE REFERRAL FEES FROM OTHER ATTORNEYS:
EVER RECEIVE COMPENSATION OTHER THAN MONEY: (i.e. 2ND TRUST DEED, CANCELLATION OF A DEBT, STOCK, BONDS, REAL ESTATE INTEREST, BUSINESS INTEREST, ETC.)
DO YOU FURNISH SERVICES IN EXCHANGE FOR GOODS OR SERVICES:
DO YOU DO PRO BONO WORK OR WORK ON A SLIDING FEE SCALE:
HOW DO YOU TRACK TIME TO DETERMINE YOUR BILLING AMOUNT:
TYPES OF PAYMENT PLANS:
EVER RECEIVE CASH PAYMENTS:
HOW MUCH AND HOW RECORDED:
OVER 10,000 RECEIVED:
DEPOSITED TO WHICH ACCOUNT:
ACCOUNTING SYSTEM: CASH ACCRUAL OTHER
ACCOUNTING SOFTWARE PROGRAM UTILIZED
FORMS 8300 FILED: (get copies);
DO YOU NOTIFY CLIENTS AT YEAR END:
UNDERSTANDING OF RESPONSIBILITY TO FILE:
WHO IS RESPONSIBLE FOR FILING:
BOOKS AND RECORDS:
WHAT RECORDS ARE KEPT:
- CHART OF ACCOUNTS
- GENERAL LEDGER
- CASH RECEIPTS JOURNAL
- CASH DISBURSEMENT JOURNAL
- ACCOUNTS RECEIVABLE/PAYABLE
- CLIENT LEDGER CARDS
- SPREADSHEET OF EXPENSES
- CHECK REGISTER
- SOURCE DOCUMENTS (invoices, stmts, etc)
- MONTHLY BANK RECONCILATION (bank stmts, ccs, dep slips)
- PROFIT & LOSS STATEMENTS
- W/P FOR TAX PREPARER
WHO KEEPS RECORDS:
WHEN AND WHERE ARE CHARGES RECORDED:
WHEN AND WHERE ARE RECEIPTS RECORDED:
WHO RECEIVES CLIENT PAYMENTS:
WHO RECORDS CLIENT PAYMENTS:
EXPLAIN HOW COSTS AND REIMBURSEMENTS ARE ACCOUNTED FOR:
HOW DO YOU ACCOUNT FOR ANY NONCASH PAYMENTS:
WHEN AND WHERE ARE EXPENSES RECORDED:
ANY PERSONAL OR BUSINESS EXPENSES PAID BY CASH:
WHEN ARE FINANCIAL STATEMENTS PREPARED: (MONTHLY QUARTERLY YEARLY)
WHO PREPARES THE STATEMENTS:
IF PREPARED BY ACCOUNTANT, WHAT INFORMATION IS GIVEN AND HOW
LOCATION OF BANK ACCOUNTS:
ANY FOREIGN BANK ACCOUNTS:
ANY FOREIGN TRANSACTIONS:
WHO PREPARES BANK DEPOSITS:
WHO MAKES DEPOSITS:
INTO WHICH ACCOUNT(S):
ANY RECEIPTS DEPOSITED DIRECTLY TO PERSONAL, TRUST OR INVESTMENT ACCOUNTS:
ARE ALL RECEIPTS DEPOSITED: (INCLUDING CASH)
ANY DEPOSITS LESS CASH:
HAVE YOU RECEIVED ANY PAYMENTS BY WIRE TRANSFER OR DIRECT DEPOSIT:
DID YOU RECEIVE ANY: (PERSONAL OR BUSINESS)
- NONTAXABLE DIVIDENDS OR INTEREST
- GIFTS OR INHERITANCES
- BONUSES, AWARDS OR PRIZES
- GAMBLING WINNINGS
- PENSIONS, ANNUITIES OR INSURANCE PROCEEDS
DID YOU SELL ANY ASSETS (BUSINESS OR PERSONAL):
DID YOU PURCHASE ANY ASSETS (BUSINESS OR PERSONAL):
CASH ON HAND BEGINNING OF YEAR:
CASH ON HAND END OF YEAR:
DO YOU HAVE A SAFE DEPOSIT BOX:
DO YOU HAVE A SAFE:
WAS ANY MONEY BORROWED DURING THE YEAR:
WHAT WAS USED FOR COLLATERAL:
WAS ANY MONEY LENT DURING THE YEAR:
FAMILY OR RELATIVES WORKING AS EMPLOYEES OR SUBCONTRACTORS:
OTHER ENTITIES OWNED BY TAXPAYER:
INVESTMENT IN OTHER ENTITIES:
TRUSTEE OF ANY TRUSTS: (BUSINESS OR PERSONAL)
BENEFICIARY OF ANY TRUSTS:
PURCHASE ASSETS FOR ANYONE ELSE:
OWN ANY INTEREST IN REAL PROPERTY:
ANY DEDUCTION, INCOME ITEM OR CREDIT DISCOVERED WHILE PREPARING FOR EXAMINATION:
QUESTIONS REGARDING SPECIFIC EXPENSES:
AUDIT TRAIL: WALK THROUGH RECEIPTS AND DISBURSEMENT TRANSACTIONS
NAME OF PERSON TO CONTACT WITH QUESTIONS DURING AUDIT:
REVIEW INITIAL IDR WITH TAXPAYER