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Part 4. Examining Process

Chapter 1. Planning and Special Programs

Section 5. Classification and Case Building (Cont. 1)

4.1.5  Classification and Case Building (Cont. 1)

4.1.5.1 
Overview

4.1.5.1.11 
Identifying Issues on Individual Returns

4.1.5.1.11.1 
Non-Business Individual Returns

4.1.5.1.11.1.14  (10-24-2006)
Copy of Schedule K–1

  1. Returns containing office examination type issues will be selected for office examination without regard to distributive type income from Forms 1065, 1120S and 1041. However, if the Schedule K–1 requires inspection, the entity’s name and year of Schedule K–1 should be listed on the classification checksheet.

  2. Items of self employment income shown on Schedule K–1 should be matched to Schedule SE to ensure that the amounts are properly included in the self employment tax computation.

4.1.5.1.11.1.15  (10-24-2006)
Moving Expenses

  1. Review Form W-2for address and other compensation. Also, consider sale of residence.

  2. Moving expenses should not be classified if the taxpayer has reported income from reimbursement from his employer. The reimbursement will be identified on the Form W-2and included in income from wages and salaries.

4.1.5.1.11.1.16  (10-24-2006)
Employee Business Expenses

  1. Amounts should be reasonable when compared to the taxpayer’s occupation and income level.

  2. Avoid auto expenses as an issue where the standard mileage computation is used and the mileage shown does not appear excessive.

  3. Transportation expenses for construction workers, carpenters, etc., who appear to have several different employers at different locations, have not proven to be productive. However, be alert for expenses claimed for travel to a remote job site(s).

  4. Expenses for clubs, yachts, airplanes, etc., must meet the facilities requirements of IRC §274 and therefore, are usually productive issues.

4.1.5.1.11.1.17  (10-24-2006)
Alternative Minimum Tax

  1. If AMT is paid, the materiality of the adjustment should be considered since an increase to the regular tax would cause a decrease to the AMT.

4.1.5.1.11.2  (10-24-2006)
Business Individual Returns

  1. Determination of Office/Field Examinations—One of the key contributions to the success or failure of our Examination Program in the business categories is the selection of the proper function to conduct the examination. If we are to meet our Program objectives, it is essential that we input those returns that are most adaptable for office interview to Office Examination and those requiring the skills of a revenue agent to Field Examination. This decision is very important from several aspects:

    1. The planned time of an examination of a business return in Office Examination is about half of that planned for Field Examination. However, substantial issues should not be excluded as identified issues to convert what would be a Revenue Agent assignment, to a Tax Compliance Officer assignment.

    2. Office examinations usually do not involve a visitation to the taxpayer’s place of business. Field examination returns should require a more in-depth knowledge of accounting principles.

  2. Generally, business returns should be selected for Field Examination when the following conditions occur:

    • Voluminous records

    • Complex accounting method

    • Extensive time frame required to complete the examination

    • Advisability of on-site inspection of business

    • Inventories are substantial and material

    • Termination of business before the end of the taxable year

    • Unusual issues that appear to be complex and time consuming to develop. For example: Nontaxable transfers; Complex oil or mineral explorations; Sale of IRC §1231assets; or Unstated interest ( IRC §483)

  3. The size of a business is also an indicator of what may be involved when an actual examination is made of the books and records of any particular taxpayer.

  4. Certain businesses would normally not be adaptable to Office Examination, such as contractors, manufacturers, auto dealers, and funeral parlors.

  5. The areas discussed above are meant to operate only as a guide. In addition to considering these items, heavy reliance must be placed on judgment and experience.

4.1.5.1.11.2.1  (10-24-2006)
Net Profit

  1. Is the taxpayer engaged in the type of business or profession normally considered to be more profitable than reflected on the return?

  2. Is the standard deduction used with high gross income and low net profit shown on the business schedule? Experience has shown that the incidence of fraud is greater on low business returns when the returns reflect large receipts , sizeable investments, and standard deductions are claimed.

  3. Do the address, real estate taxes and/or mortgage interest indicate a higher standard of living than justified by the reported income?

  4. Does the return reveal large amounts of interest/dividend income not commensurate with current sources of income?

4.1.5.1.11.2.2  (10-24-2006)
Cost of Goods Sold

  1. Check for the possibility of withdrawal of items for personal use.

  2. Is the ending inventory inclusive of all costs, direct and indirect?

4.1.5.1.11.2.3  (10-24-2006)
Bad Debt Deduction

  1. Is it a cash business?

  2. Is it disproportionate for the indicated value of sales?

4.1.5.1.11.2.4  (10-24-2006)
Depreciation

  1. Does the schedule contain an adequate description of the asset?

  2. Are personal assets being depreciated?

  3. Consider sales of property simultaneously with depreciation issues.

4.1.5.1.11.2.5  (10-24-2006)
Sale of Assets

  1. Is there a sale of business assets during the year without depreciation recapture?

  2. Is the gain large enough to require the alternative minimum tax computation?

4.1.5.1.11.2.6  (10-24-2006)
Farm Returns

  1. In the analysis of a Schedule F, you should keep in mind the usual features of a farm return. The farmer may be engaged in a specialized area of dairy cattle, beef cattle, grain, swine, vegetables, poultry, or a multiple of these items. The operation may vary from that of a few acres to several thousand acres. The operator of the farm may rent all the land farmed or may own all or a portion of it. Consider whether the farm is an actual business operation or a hobby.

  2. Consider whether payments from farmers’ cooperatives are reported.

4.1.5.1.11.2.7  (10-24-2006)
Self Employment Tax

  1. All returns should be screened for self employment tax issues, including returns with Schedule SE attached. Look for income such as director’s fees, janitorial services, miscellaneous income, partnership income, etc., which may be subject to self-employment tax.

  2. Some items of income earned by independent contractors may be reported as wages or other income. Where the income appears to be personal service income, it must be considered for Social Security Tax purposes.

4.1.5.1.12  (10-24-2006)
Employee Returns

  1. Please refer to IRM 4.1.4.2.10for classification, selection and procedures related to all types of employee return examinations.

4.1.5.1.13  (10-24-2006)
Identifying Issues on Corporation Returns

  1. Classifiers must scrutinize corporation returns both as to line items and the return as a whole to identify and select returns with the highest examination potential.

  2. Classifiers will consider the grade level of the examiner that should ultimately examine the return when classifying/screening corporate returns.

4.1.5.1.13.1  (10-24-2006)
Corporate Classification—General

  1. You are responsible for selecting those corporate returns which are most in need of examination.

  2. The objectives of maximizing revenue, fostering taxpayer equity, and promoting voluntary compliance, must be considered.

  3. Corporate income tax returns are either computer classified under the DIF System or manually classified (Non-DIF).

  4. The corporate DIF System includes returns in Activity Codes 203 through 217. All other corporate returns are Non-DIF.

  5. Non-DIF returns are further identified as Automatics or Specials (returns that meet one or more specific conditions). Non-DIF Special returns may contain any of the following criteria: International features, Joint Committee aspects, or Miscellaneous refundable credits.

  6. Classification of the corporation return must include the balance sheet and Schedule M items. Substantial change in accounts receivable, reserve for bad debts, loans to or from stockholders, accounts payable, treasury stock, capital stock, or retained earnings would indicate an examination of these items may be warranted. In addition, such potential issues as a " Thin Corporation," IRC §531, substantial changes in accruals, and decreases in assets which are not accounted for on Schedule D of the return may be identified from an inspection of the balance sheet.

  7. All Schedule M items should be scrutinized to determine the difference between income shown on the books, and taxable income shown on the tax return.

  8. The following general items must also be considered during classification:

    1. Overall composition of the return. Is the return complete, containing all necessary information and schedules? Who prepared the return?

    2. Data reported on the return compared to the norms and standards of the business or industry of the taxpayer.

    3. Location of the business. This could have a bearing on the volume of business.

    4. Prior examination results as indicated on Form 5546, Examination Return Charge-Out.

    5. The existence of controlled groups, interests in foreign corporations, deductions for facilities, or convention expenses.

    6. Experience has shown that the following characteristics result in potentially productive features: International features; Copy of a National Office approved Technical Ruling attached, but all conditions as set forth in the Ruling have not been met; New corporation, which incorporated a going business and reflects goodwill, other boot, or accelerated depreciation; Liquidation under IRC §331, IRC §332, IRC §333, IRC §337 (these generally trigger recapture under the provisions of IRC §47, IRC §1245, and IRC §1250 ); A consolidated return, especially one that does not contain schedules showing each member’s respective share of income, expense, assets, liabilities, and capital; A short period return; Credits and/or losses that have been carried forward when information on the return indicates the item(s) should have been carried back; A member of a controlled group, claiming the full amount of the surtax exemption, etc., and not including a properly executed election; Last-In, First-Out (LIFO) inventory method being used for the first time; Manufacturing concern not using the Full-Absorption accounting method to value inventory; Substantial passive income which may indicate a Personal Holding Company; A low asset return, reflecting a net operating loss; Returns with Minimum Tax issues; and Foreign Tax Credit claimed on the return.

4.1.5.1.13.2  (10-24-2006)
Profit and Loss Method

  1. After considering the general guidelines above, you should begin a more detailed review of the return utilizing both the profit and loss, and balance sheet approaches. Some of the items to be considered under the profit and loss approach are.

    1. Large or unusual changes in inventories, or no inventory reflected for nonservice type business.

    2. Sales of assets without a Schedule D or Supplemental Schedule of Gains and Losses ( Form 4797) attached.

    3. No amount claimed as amortization on a newly formed corporation.

    4. Amounts claimed as Other Deductions without supporting schedules attached.

    5. Questionable bad debt, either under the Specific Write-off or Reserve Method.

    6. Expenses which may be high or unusual for the type of business.

4.1.5.1.13.3  (10-24-2006)
Balance Sheet Method

  1. A balance sheet approach, paying particular attention to substantial changes between opening and closing balances, can disclose a number of potential issues:

    1. Cash: Large ending balance—possible IRC §531 issue; and/or negative balance—improper accruals.

    2. Trade Notes and Accounts Receivable: Change in accounting method; premature write-offs; excessive deduction for bad debts; and/or interest income unreported.

    3. Inventories: Change in method of valuation; change in nature of business; and/or possible write-down.

    4. Investments: Interest income and dividend income understated or omitted, expense(s) of tax-free income deducted; unreported sales, erroneous basis, installment election; stockholder loans buried; and/or related issue.

    5. Other current assets—deferred expenses.

    6. Loans to stockholders—dividend issue.

    7. Building and other depreciable assets: Unreported sales; investment credit recapture; and/or incorrect basis.

    8. Intangible assets: Goodwill has been written-off, sale of license or patent; and/or IRC §351.

    9. Loans from stockholders: Thin corporation; and/or interest deduction vs. dividend.

    10. Other liabilities: Improper accruals; deferred income accounts; and/or reserve for contingencies.

    11. Capital accounts: Unreported sale; stock issued for services; and/or thin corporation.

    12. Paid-in surplus: Diversion of earned income; and or IRC §351.

    13. Retained earnings — IRC §351.

    14. Treasury Stock: Potential dividend to stockholders and/or bargain purchase by a stockholder.

    15. Schedules M–1 and M–2: All items should be reviewed for proper tax treatment.

4.1.5.1.14  (10-24-2006)
Form 1120S Special Compliance Problems

  1. Distribution of net operating losses to stockholders in excess of their basis.

  2. Repayment of stockholder’s loans by the corporation where distribution of losses exceeds stockholder’s basis.

  3. Disqualification of election because of changes in stock ownership or amount of passive investment income.

  4. Distributions and/or dividend payments made to shareholders in lieu of wages to avoid employment taxes. Rev. Rul. 74–44 , Rev. Rul. 74–1 C.B. 287.

4.1.5.1.15  (10-24-2006)
Partnership Issues

  1. Partnership returns are identified by three categories; DIF, non-DIF, and Automatics. Returns with 10 partners or less, which do not meet automatic criteria, are scored under the DIF system. Returns with 11 or more partners and returns which meet automatic criteria, regardless of size, are not computer classified. Automatic criteria are contained in the LEM.

  2. Screening procedures for DIF scored partnership returns are essentially the same as for other DIF returns.

  3. Significant issues identified on non-DIF partnership returns will be reflected on Form 6250 Partnership Classification Checksheet or Form 10264.

4.1.5.1.15.1  (10-24-2006)
Partnership Selection Features

  1. The general instructions for individual and corporate returns apply equally to partnership returns. The returns must be scrutinized both as to line items and the return as a whole in selecting returns with the highest examination potential.

  2. Initial and first year returns are often productive. Common issues are:

    1. Contributions to capital for possible recognition of gain or loss at the partners’ levels.

    2. Partners with no contributed capital where services may have been performed in exchange for the partnership interest.

    3. Large loss claimed on returns commencing business late in the year.

    4. Large loss claimed in relation to investment.

    5. Loss claimed in excess of investment through nonrecourse financing. Loan and prepaid interest costs should be amortized over the life of the loan.

    6. Large depreciation deduction where property may not have been placed in service during the year.

    7. Pre-opening expense (management fees, license fees, etc.) which should be capitalized.

  3. Other areas applicable to partnerships:

    1. Additional contributions by a partner which could constitute a sale or exchange.

    2. Disproportionate allocation of losses or specific deductions to partners. Review Schedule K–1 to determine the date of entry of new partners.

    3. Withdrawal by partners may include " phantom gain" through assumption of liabilities by others.

    4. The sale or exchange of partnership assets may result in recapture of ordinary income.

    5. Component or other depreciation method resulting in shorter than guideline lives.

4.1.5.1.15.2  (10-24-2006)
Partnership Distributions

  1. In general, errors are common in final year partnership returns. Basis and recognition vs. non-recognition of gain or loss are often issues needing examination.

4.1.5.1.16  (10-24-2006)
Partnership Control System (PCS)

  1. The Partnership Control System was designed to control and monitor flow through entity and linked investor returns (whether TEFRA or non-TEFRA). Detailed information regarding the PCS system is contained in other areas of the IRM.

  2. Upon receipt of the return or Form 5546Charge-Out Document, the PSP Territory Manager will:

    1. Determine if there are issues other than partnership, fiduciary, or small business corporation issues on the return which warrant examination. If so, the case will be updated on AIMS and assigned to a group.

    2. If the return is open and in another organizational unit in the Area, the Form 5546 will be forwarded to that function.

    3. If the return is charged-out to a campus, contact the campus to secure the return.

    4. If the Form 5546 contains "Return in Transit" in the Special Message portion, hold the Form 5546 until the return is received.

  3. Partner returns controlled by the Areas pending completion of the partnership examination will be held in Status 41.

4.1.5.1.17  (10-24-2006)
Fiduciary Returns

  1. Manual screening of fiduciary returns requires consideration of issues that are peculiar to fiduciary returns. While income tax issues will not be overlooked, quality classification/screening requires consideration of the following issues and areas:

    1. Information omitted (date created, name of grantor, trust instrument or will).

    2. Estate unduly prolonged (should not be more than 5 years unless very large) ( Reg. 1.641(b)–3(a)).

    3. Business Trust taxable as a corporation ( IRC § 7701(a)(3)), Rev. Rul. 75–258.

    4. Exemption—Estate $600; Simple Trust $300; Complex Trust $100.

    5. Indication of multiple trusts, which may be taxable as one trust (Reg. 1.663(c)–1(b)).

    6. Minimum tax ( IRC 56)—tax preference items and/or exemption not apportioned between the estate or trust and beneficiaries based on share of income; also, prorate for short year.

    7. Wrong tax rate schedule used.

    8. Foreign tax credit, and job tax credit not apportioned between estate or trust and beneficiaries based on income.

    9. Normally a trust cannot show Subchapter 5 income ( IRC §643(a)).

    10. Indication of income taxable to grantor or another ( IRC §671 thru IRC §678) (e.g., sale and leaseback among related parties).

    11. Error in computation of Distributable Net Income (DNI) ( IRC §643(a)).

    12. Rental or other income (i.e., from non-probate assets) may be taxable to devisees ( IRC §691).

    13. Partnership income; decedent’s death before close of partnership taxable year. Share of partnership income erroneously included on Form 1040 instead of Form 1041.

    14. Special tax for trusts electing to report gain realized on the sale of property acquired from a transferor under installment method ( IRC §644).

  2. Distributions to Beneficiaries:

    1. Beneficiaries not listed. May not have picked up income.

    2. Normally estate is not required to distribute all income currently. No deduction is allowable if amount was not actually distributed.

    3. Normally an estate does not distribute capital gains.

    4. Simple trusts must distribute all ordinary income ( IRC §651) except income allocable to corpus.

    5. Final year—all income deemed distributed, including capital gains ( IRC §643(a)(3) and IRC §662(a)(2)

    6. No losses or excess deductions are distributable except in final year ( IRC §642(h)).

    7. Distribution deduction may include: Specific legacy—not deductible ( IRC §663(a)); or Widow’s allowance—deductible if from current income (Reg. 1.661(a)–2(c)) and taxable to widow.

    8. Excess (accumulated) distribution may indicate a complex trust. A separate Schedule J may be missing—reported by beneficiaries (Throwback Rule IRC §665(b)).

    9. Administrative and other expenses may actually be a disguised distribution to beneficiary. Failure to file Form K–1 (e.g., family allowance).

    10. Excess distributions may indicate payment of specific legacies on which estate may have realized a gain.

    11. Nonresident alien beneficiary — were Forms 1042S filed and required amounts of tax withheld?

    12. Terms of governing instrument (local law issues).

    13. Family Trust?

  3. Capital Transactions:

    1. Normally there should be no significant capital losses in the first year of an estate.

    2. Capital loss (net) improperly claimed.

    3. Deduction limited to fiduciary’s portion of capital gains ( IRC §1202.

    4. Basis of assets: Estate of testamentary trust—carryover basis ( IRC 1023); Inter-vivos trust—usually the donor’s basis ( IRC §1015); or income in respect of a decedent ( IRC §691).

    5. Redemption of closely held stock may be dividend unless IRC 303is complied with ( IRC §302).

    6. Sale or exchange between related parties for inadequate consideration.

    7. Estate tax marital deduction—executor satisfies pecuniary bequest with appreciated assets, thus triggering a capital gain.

    8. Specific bequest—executor satisfies with appreciated assets, thus triggering a capital gain.

  4. Expenses and Deductions:

    1. Allocation of expenses to tax-free income not made ( IRC §265).

    2. Depreciation taken (basis).

    3. Allocation of expenses.

    4. Funeral and medical expenses not deductible ( IRC §641(b) and IRC §162(a) ).

    5. Other personal expenses and losses not deductible ( IRC §641(b) and IRC §162(a)) (e.g., child care, funeral costs, medical expenses).

    6. Administrative expenses (e.g., attorney’s and CPA’s fees, and executor commissions) not deductible unless waiver for estate tax purposes made ( IRC §642(g)). Also, no "double deduction" allowed for selling expenses used to offset the sales price on a sale of property in determining gain or loss if deducted for Federal Estate Tax purposes.

    7. Federal Estate Tax on income in respect of a decedent (computation omitted or erroneous) ( IRC §691(c) ). Estate tax examination will affect the computation.

    8. Inheritance taxes are not deductible ( IRC §164(b)(4)).

    9. Charitable contributions-"set aside " amount is generally not deductible ( IRC §164(b)(4) ).

    10. Executor’s commissions or attorney’s fees appear unreasonable under local law guidelines.

4.1.5.1.18  (10-24-2006)
Excise Tax Issues

  1. In most cases, excise tax returns do not in themselves provide a basis for classification. Classification is performed by excise tax specialists.

  2. You should be cognizant of potential excise tax liabilities when screening income tax returns. Be alert for:

    1. Gasoline tax credit for aviation gasoline or gasoline used for non-highway purposes. The first credit is not allowable. The second instance indicates that the taxpayer could be liable for highway use tax.

    2. Taxpayers with trucking operations may be liable for highway use tax, further manufacturers excise tax, and/or diesel fuel-gasoline taxes.

    3. Returns indicating issuance of policies by foreign insurers. This would involve returns of insurance agencies, brokers, etc.

    4. Returns reporting manufacturing or use of pistols, revolvers, and firearms Examples are gun shops, target ranges, etc.

    5. Returns reporting flying services or aircraft sales. Examples are charter service, flying schools, airplane repairs, etc.

4.1.5.1.19  (10-24-2006)
Employment Tax issues

  1. Employment tax returns do not in themselves provide a basis for classification. Independent selection of returns should be based on known or probable areas of noncompliance.

  2. You should be cognizant of potential employment tax issues when screening income tax returns.

  3. Known or probable areas on noncompliance are listed the IRM Handbook for Employment Tax Examination Program.

4.1.5.1.20  (10-24-2006)
Returns with Collectibility Indicators

  1. The purpose of the Internal Revenue Service is to collect the proper amount of tax revenues at the least cost to the public, and in a manner that warrants the highest degree of public confidence in our integrity, efficiency and fairness.

  2. What Examination does impacts on other functions throughout the Service. Closed cases can have an impact on the workloads in Appeals, Counsel and Collection. Assessments made by Examination often result in an increase in the inventory of cases in Collection. A significant number of these assessments result in uncollectible accounts.

  3. In the continuing effort to reduce the Collection Inventory and Currently Not Collectible (CNC) Accounts, the Service must strive for quality assessments and promote an increased emphasis on early collections. Taxpayers should be educated as to the benefits of paying a proposed tax deficiency in full or informed as to the availability of other arrangements (i.e., installment payments).

  4. A CNC account is a taxpayer account that has been determined to be uncollectible for one or more of the following reasons:

    • Hardship

    • Insolvency/defunct corporation

    • Bankruptcy

    • Decedents (having no assets)

    • Unable to locate taxpayer

    • Unable to contact taxpayer

    • In business (hardship)

    • Other (de minimus/statute expired while in active status)

  5. The goal of the CNC initiatives is to constrain the growth of accounts receivable and uncollectible accounts and to promote a more effective organizational operation by maximizing time and resources devoted to productive efforts

4.1.5.1.20.1  (10-24-2006)
Classification Procedures-Collectibility Indicators

  1. PSP Territory Managers must ensure that classification checksheets are documented to reflect an overriding compliance justification for conducting an examination on a taxpayer with low collection potential.

  2. Collectibility Indicators appear on the Examination Return Charge-Out ( Form 5546) or on an AMDISA print. Definitions and locations of each indicator are as follows:

    BANKRUPTCY Taxpayer is currently in bankruptcy or bankruptcy discharge in a prior period.
    CURNOTCOLL Prior period was closed as Currently Not Collectible.
    COLLSTCD26 Open Collection status (i.e. assigned to Revenue Officer, Automated Collection, or is in Collection queue).
    OIC Offer-in-Compromise Pending

    Location of Indicators:  
    Examination Return Charge-Out ( Form 5546) Line 18, left side of page. Display: BANKRUPTCY, CURNOTCOLL, COLLSTCD26, or OIC
    AMDISA Print Line 22 of Page 1. Display: BANKRUPTCY, CURRNOTCOLL, or COLLSTCD26

  3. The following actions should be taken if a Collectibility Indicator is reflected on the Charge-Out Document or an AMDISA print. These procedures apply to classification of any type of inventory:

    1. Returns will be classified and either Accepted as Filed or Selected for Examination based upon the potential for change in examination. On returns selected for examination, the classifier must document the consideration of the Collectibility Indicator in the remarks section of the classification check sheet. A statement such as "Collectibility Indicator considered in selecting this return for audit" should be included on the checksheet.

    2. The Collection Indicators are systemic flags to alert the examiner and classifier to consider collection potential. In some instances, the indicator may not be based on current information (for example, bankruptcy discharge 7 years prior). The classifier or coordinator may need to obtain additional IDRS research to make a selection decision.

    3. 3. The returns containing Collectibility Indicators that are selected for examination by the classifier must be reviewed by the PSP classification coordinator or the manager responsible for the classification detail. If the classification reviewer agrees that the return should be selected for examination, they will attach a Form 3198 to the return and indicate in the remarks section "Examiner Alert -- Collectibility Indicator (B, N, C, or O)"

    4. The selected cases with collectibility indicators will not be stored at the campus but will be direct shipped to the PSP.

4.1.5.1.20.2  (10-24-2006)
"BANKRUPTCY" Coded Returns

  1. The PSP Territory Manager, will consult with the PSP Bankruptcy Coordinator and the Insolvency Manager function in determining whether to select the return. PSP will hold the return awaiting advice from Insolvency concerning the bankrupt taxpayer.

  2. Insolvency Support will advise Examination, through the PSP Bankruptcy Coordinator, as to the type of bankruptcy, etc. This information will then be provided to PSP.

  3. If Insolvency Support advises PSP that the bankruptcy case is open, PSP should consider their advice in determining whether the examination of the taxpayer is worthwhile. The return may be surveyed unless there are specific reasons to examine. Specific reasons could include potential fraud, frivolous filings or manipulation of bankruptcy laws/procedures.

4.1.5.1.20.3  (10-24-2006)
"CURRNOTCOLL" Coded Returns

  1. The "CURRNOTCOLL" code on the return indicates a taxpayer has an outstanding tax balance which has not been satisfied and is considered currently not collectible. Although this code implies the account is not collectible, it should be noted that the outstanding balance will remain on the Master File during the entire statutory collection period (10 years from the date of assessment). For example, the taxpayer’s account may reflect an outstanding tax balance from 7 years ago; however, the taxpayer may now be financially able to pay. Any account that has a Transaction Code (TC) 530 will also include a Collection closing code. Each closing code designates the reason the account was closed as currently not collectible. See Document 6209, ADP and IDRS Information, for a complete list and explanation of these TDA closing codes.

4.1.5.1.20.4  (10-24-2006)
"COLLSTCD26" Coded Returns

  1. The "COLLSTCD26" code on the return is an additional information element to be considered during an examination. It reflects a Collection Status 26, field contact.

  2. Upon receipt of a "COLLSTCD26" coded return in the Area, the PSP Territory Manager will order SUMRY and TXMOD research. If the case is still in Collection Status 26, the SUMRY and TXMOD information will reflect a group and employee number of the revenue officer charged with the account.

  3. PSP should coordinate with the Collection liaison before the return is sent to the group to determine the assigned revenue officer’s name and telephone number. Contact should be made with the revenue officer and a request made for the collection status of the case.

  4. Based on the facts and circumstances and feedback received from Collection, a determination should be made as to the examination potential.

4.1.5.1.20.5  (10-24-2006)
"OIC" Coded Return

  1. The "OIC" code on the return indicates an Offer in Compromise is pending for the taxpayer.

  2. Upon receipts of an "OIC" coded return in the Area, TXMOD research will be secured.

  3. PSP should coordinate with the Collection liaison before the return is sent to the group to determine the collection status of the case.

  4. Based on the facts and circumstances and feedback received from Collection, a determination should be made as to the examination potential.

4.1.5.2  (10-24-2006)
Case Building Overview

  1. Various studies have been conducted throughout the years to determine the value of having certain information available during the pre-examination analysis of a tax return vs. gathering the information during the examination process. These studies have concluded that the resources expended gathering this information for the pre-examination (classification) phase are more than offset by the savings incurred in pursuing non-productive issues/returns.

  2. The studies weighed the value of information available during the pre-examination stage and determined that certain items should be made part of the case file for classification purposes. These items are:

    1. Case building inventory sheet

    2. Charge out document , Form 5546

    3. Original return

    4. Three year MACS print

    5. IDRS prints of various command codes

    6. CBRS (Currency and Banking Retrieval System) information

    7. Taxpayer locator data compiled from various public information agencies

  3. Additionally, there may be other related entities that may materially impact the taxpayer’s tax liability. For instance, the sole source of the taxpayer’s income may be a partnership that is reflected as an entry on a schedule. This income may be offset with other non-related items. This makes it difficult to properly determine the taxpayer’s correct liability without considering the items attributable to that taxpayer from the partnership. When this situation is identified the information from the related entity should be gathered and associated with the taxpayer’s file.

  4. Case building can be done in the Area PSP office, but is generally performed at the Campus.

  5. Please see the Exam Planning and Delivery web site for more updated information on Case Building, http://sbse.web.irs.gov/EPD/

4.1.5.2.1  (10-24-2006)
Case Building Benefits

  1. Case building tools help determine whether a return should be selected for examination, what issues should be examined, and how the examination should be conducted.

  2. Case building data provides taxpayer specific research to identify possible compliance issues.

  3. In conjunction with the original return, case building data provides a broader working knowledge of the taxpayer's financial activities to make an informed decision to accept or examine specific items on the return.

  4. Case building data can corroborate items on the return so they don't have to be raised with the taxpayer.

4.1.5.2.2  (10-24-2006)
IDRS (integrated Data Retrieval System

  1. IDRS is an internal database accessed by various command codes, each of which provides specific information.

  2. IDRS can provide:

    1. Current name/address and filing status

    2. Income sources and amounts

    3. Examination activity

    4. Filing requirements

    5. Bankruptcy indicators

    6. Filing status and number of dependents

    7. Prior names/addresses

    8. Filing and payment transactions

    9. Cross reference to other taxpayer identification numbers (TINS)

  3. The IDRS information should be compared against the return information to determine if there are discrepancies.

4.1.5.2.3  (10-24-2006)
CBRS (Currency and Banking Retrieval System)

  1. CBRS is an on-line database containing reports of cash transactions in excess of $10,000. Cash transactions include deposits, withdrawals, check cashing, wire transfers, sales and redemption of money orders, travelers’ checks or stored value, casino activity, payments for certain services and information on foreign bank accounts. In addition, CBRS contains reports of cash and/or other monetary instruments in excess of $10,000 used as payment for certain goods.

  2. CBRS provides:

    1. Form 4789, Currency Transaction Report (CTR) for cash transactions in excess of $10,000, filed by financial institutions and non-bank financial institutions

    2. Form 8300, Report of Cash Payments over $10,000, filed by businesses when cash and/or monetary instruments of $10,000 or more are received for goods or services

    3. Form 8362, Currency Transaction Report by Casinos (CTRC) or Nevada Form 8852 (CTRC-N), filed by casinos for cash transactions (cash in or cash out) in excess of $10,000.

    4. Form FBAR, Report of Foreign Bank and Financial Accounts, filed by an individual, if the aggregate value of foreign accounts exceeds $10,000

  3. CBRS can generate leads for potential unreported income, money laundering transactions and other tax avoidance schemes

  4. Consider CBRS activity in relation to the overall financial status of the taxpayer. CBRS "hits" along with IRP, MACS, and taxpayer locator data will provide a better picture of the taxpayer’s financial situation. Compare the contents of these case building tools with the return.

4.1.5.2.4  (10-24-2006)
Taxpayer Locator Services

  1. The Public Records Search Report was initially developed for the NRP Study. This report provides information on an individual, and is designed as a general combination report with data from multiple sources to provide a snapshot of the subject's identity.

  2. At least one consumer reporting agency is scanned and the information found is utilized to search over 2 billion public records. A single report of search results is generated and may include:

    • Complete name, AKAs current and previous addresses

    • Social Security number

    • Driver license number

    • Date of birth

    • Bankruptcies, liens, judgements

    • Corporate ownership

    • UCC (Uniform Commercial Code) filings

    • Real property ownership

    • Aircraft and watercraft ownership

    • Pilot licenses

  3. This information is useful in determining the taxpayer’s lifestyle and aids in determining net worth.

  4. Examples of public search data that could indicate examination potential include:

    • Deed transfer information that reflects sales not reported on tax return.

    • Corporate affiliations where there are no indications of corporate earnings on the return.

    • Property ownership that is not reflected on the return as either personal residence or rental property.

    • Professional licenses that could demonstrate income earning potential not reflected on the tax return.

    • Vehicle searches – ownership data (type of vehicle, purchase price, owner name and address) that could reflect high cost asset acquisition in excess of earnings reported on the tax return.

    • Address history data – contains up to five addresses for the taxpayer in the most recent to least recent order. Could aid the financial status analysis; high and low cost living areas.

    • Boat/Plane registration – ownership of high cost assets in excess of earning potential reflected on the tax return.

4.1.5.2.5  (10-24-2006)
Use of Colored File Folders

  1. Exam needs to achieve consistency nationwide by using colored file folders on cases to develop national standards for processing. This subsection provides guidance to establish a uniform list of colored file folders that Exam will use to identify specific types of cases.

  2. For case building purposes, whether performed by Area PSPs or at the Campus, the following file folder color guidelines will be used:

    1. Red – Case with a statute date expiring within 180 days

    2. Yellow – Headquarter approved usage only. Purpose of use will change periodically as interim guidance is issued.

    3. Orange – IRS Employee audit

    4. Lavender – NRP Form 1040

    5. Plum – NRP Form 1120S

    6. Light Blue – Claims (This includes innocent spouse; injured spouse; and any other type of claim). The type of claim should be notated on Form 3198.

  3. The list above is not all-inclusive. From time to time there will be various projects that will require the use of a particular colored folder, exclusive of the colors listed above.

  4. If a case falls into more than one of the above listed categories, place the colored folders in the order listed above with the highest importance as the outermost folder.

Exhibit 4.1.5-1  (05-19-1999)
Form 5546 Examination Return Charge Out

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