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  (08-24-2012)
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 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-2 for 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-2 and 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 definition of IRC 274 and therefore, are usually productive issues.

4.1.5.1.11.1.17  (10-24-2006)
Alternative Minimum Tax (AMT)

  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  (08-24-2012)
Business Individual Returns

  1. Determination of Office or 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 we input those returns that are most adaptable for office interviews 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 substantially less than the planned time 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. The areas discussed below are meant to operate only as a guide. In addition to considering these items, heavy reliance must be placed on judgment and experience.

  3. Generally, business returns should be selected for field examination when any of the following conditions is anticipated:

    • 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

      Example:

      Nontaxable transfers; complex oil or mineral explorations; sale of IRC 1231 assets; or unstated interest (IRC 483

      )

  4. 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.

  5. Certain businesses would normally not be adaptable to office examination, such as contractors, manufacturers, auto dealers, and funeral parlors.

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 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 and 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  (08-24-2012)
Farm Returns

  1. In the analysis of a Schedule F, you should keep in mind the unique 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  (08-24-2012)
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 self-employment tax purposes.

4.1.5.1.12  (08-24-2012)
Employee Returns

  1. Please refer to IRM 4.1.4.2.10, Employee Audits for classification, selection, and procedures related to employee audits.

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  (08-24-2012)
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 scored 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

    • 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 Sheet.

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

4.1.5.1.13.2  (08-24-2012)
Potentially Productive Issues on a Corporate Return

  1. Experience has shown the following characteristics result in potentially productive issues:

    • New corporation which incorporated a going business and reflects goodwill, other boot, or accelerated depreciation

    • International Features: a copy of a National Office approved technical ruling attached, but all conditions set forth in the ruling have not been met

    • 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 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

    • Foreign tax credit claimed on the return

4.1.5.1.13.3  (08-24-2012)
Profit and Loss Method

  1. After considering the general guidelines and potentially productive issues 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 non-service type business.

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

4.1.5.1.13.4  (08-24-2012)
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 party issues.

    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 versus 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  (08-24-2012)
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, 1974-1 C.B. 287, Small Business Corporation Dividends Paid Instead of Salaries.

4.1.5.1.15  (08-24-2012)
Partnership Issues

  1. Partnership returns are identified by three categories; DIF, non-DIF, and automatics. Returns which do not meet automatic criteria, are scored under the DIF system. Returns which meet automatic criteria, regardless of size, are not computer classified. Automatic criteria are contained in IRM 4.19.11.1.9, Form 1065, U.S. Partnership Return of Income.

  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, Revenue Agent - Classification Checksheet.

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 non-recourse 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 versus non-recognition of gain or loss are often issues needing examination.

4.1.5.1.16  (08-24-2012)
Partnership Control System (PCS)

  1. The partnership control system (PCS) was designed to control and monitor flow through entity and linked investor returns (whether TEFRA or non-TEFRA). Detailed information regarding the PCS system can be found in IRM 4.29, Partner Control System (PCS) Handbook.

  2. Upon receipt of the return or Form 5546, Examination Return Charge-Out Sheet, 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 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) (Treas. Reg. 1.641(b)–3(a)).

    3. Business trust taxable as a corporation (IRC 7701(a)(3)) and 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 (Treas. 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. Trusts normally cannot show Subchapter 5 income (IRC 643(a)).

    10. Indication of income taxable to grantor or another ( IRC 671 through 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 (e.g., 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. Estates are normally not required to distribute all income currently. No deduction is allowable if amount was not actually distributed.

    3. Estates normally do 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. Losses or excess deductions are not 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 (Treas. 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 — where Form 1042S, Foreign Person's U.S. Source Income Subject to Withholding filed and required amounts of tax withheld?

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

    13. Family trust?

  3. Capital Transactions:

    1. Significant capital losses normally should not occur 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 303 is 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  (08-24-2012)
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 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.

      Example:

      Gun shops, target ranges, etc.

    5. Returns reporting flying services or aircraft sales.

      Example:

      Charter service, flying schools, airplane repairs, etc.

  3. Known or probable areas on non-compliance are listed in IRM 4.24.3, Selection, Assignment and Monitoring of Workload.

4.1.5.1.19  (08-24-2012)
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 non-compliance are listed in IRM 4.23.3, Classification, Selection and Assignment of Employment Tax Cases.

4.1.5.1.20  (08-24-2012)
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. Cases audited by Examination impact other functions (e.g, Collection, Appeals, Counsel, etc.) throughout the Service.

  3. 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.

  4. 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 (e.g., installment payments).

  5. A CNC account is a taxpayer account 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)

  6. The goal of the CNC initiative 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.

  7. See IRM 4.20.2.2, General Collectibility Considerations for more guidance.

4.1.5.1.20.1  (08-24-2012)
Classification Procedures — Collectibility Indicators

  1. PSP Territory Managers must ensure 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 Form 5546, Examination Return Charge-Out Sheet, Taxpayer Information Sheet, or on an AMDISA print. Definitions and locations of each indicator are as follows:

    Form 5546 CDE TP Info Sheet Definition
    BANKRUPTCY 1 Taxpayer is currently in bankruptcy or bankruptcy discharge in a prior period.
    CURNOTCOLL 2 Prior period was closed as Currently Not Collectible.
    COLLSTCD26 3 Open Collection status (e.g. assigned to revenue officer, Automated Collection, or is in Collection queue).
    OIC 4 Offer-in-Compromise Pending

    Document Location of Indicators:
    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
    CDE Taxpayer Information Sheet Line 2, Collectibility Indicator. Display: 1, 2, 3, or 4

  3. The following actions should be taken if a Collectibility Indicator is reflected on the examination return charge-out document, an AMDISA, or the CDE Taxpayer Information Sheet. These procedures apply to classification of any type of inventory (except National Research Project (NRP) 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. The returns containing collectibility indicators 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 the return should be selected for examination, they will attach a Form 3198, Special Handling Notice for Examination Case Processing, to the return and indicate in the remarks section "Examiner Alert -- Collectibility Indicator (B, N, C, or O)" .

    4. The selected cases with bankruptcy and offer in compromise (OIC) indicators will not be stored at the Campus but will be direct shipped to the PSP.

4.1.5.1.20.2  (08-24-2012)
"BANKRUPTCY" Coded Returns

  1. The PSP Territory Manager, will consult with the PSP Bankruptcy Coordinator and the Insolvency 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 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  (08-24-2012)
"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 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, IRS Processing Codes and Information, for a complete list and explanation of these Taxpayer Delinquent Account (TDA) closing codes, or http://serp.enterprise.irs.gov/databases/irm.dr/current/6209.dr/6209ch11.8.5.htm.

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  (08-24-2012)
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 versus gathering the information during the examination process. These studies have concluded 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 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 or Taxpayer Information Sheet from CDE facsimile

    3. Original return (only in special circumstances (e.g. strategy cases, non-electronically filed returns, fraud, etc.)

    4. Three year CDE facsimile print

    5. IDRS prints of various command codes

    6. Currency and banking retrieval system (CBRS) information

    7. Taxpayer locator data compiled from various public information agencies

    8. yK1 Link Analysis Tool, in some cases, may also be provided. This tool is useful if you have related entities or tiered ownership issues

  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.

4.1.5.2.1  (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. Case building data in conjunction with the original return, 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  (08-24-2012)
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 and 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, amended returns, or activity after the return was filed.

  4. An IDRS Command Code Job Aid can be found at http://serp.enterprise.irs.gov/databases/irm-sup.dr/job_aid.dr/command-code.dr/idrs_command_codes_job_aid.htm

4.1.5.2.3  (08-24-2012)
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. FinCen Form 104, Currency Transaction Report, for cash transactions in excess of $10,000, filed by financial institutions and non-bank financial institutions.

    2. FinCen Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business, filed by businesses when cash and/or monetary instruments of $10,000 or more are received for goods or services.

    3. FinCen Form 103, Currency Transaction Report by Casinos, filed by casinos or card clubs for cash transactions (cash in or cash out) in excess of $10,000.

    4. Treasury Form TD F 90-22.1, Report Of Foreign Bank And Financial Accounts filed by an individual, if the aggregate value of foreign accounts exceeds $10,000.

    5. FinCen Form 105, Report Of International Transportation Of Currency Or Monetary Instruments. This form is filed by anyone carrying cash or monetary instruments in excess of $10,000 into or out of the country.

  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, CDE 3 year facsimiles, 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 and generate a single report that may include:

    • Complete name, AKAs

    • Current and previous addresses

    • Social security number

    • Driver license number

    • Date of birth

    • Bankruptcies, liens, and 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 could reflect sales not reported on tax return.

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

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

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

    • Vehicle searches ownership data (type of vehicle, purchase price, owner name and address) 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. This data could aid in the financial status analysis when determining high and low cost living areas.

    • Boat and Plane registration could reflect ownership of high cost assets in excess of earning potential reflected on the tax return.

4.1.5.2.5  (08-24-2012)
Use of Colored File Folders

  1. Examination 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 210 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. 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, Special Handling Notice for Examination Case Processing

    6. Burgundy – NRP BMF Studies

    7. Dark Purple – NRP Form 1120

  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 
Form 5546, Examination Return Charge Out Sheet

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