4.10.8  Report Writing (Cont. 1) 
Claims  (06-10-2005)
Inviting Claims in Overassessment Cases

  1. Taxpayers will be invited to file claims in the following types of cases if the proposed overassessments are not already covered by claims:

    1. Cases to be referred to Appeals in the " 90–Day" status when a period of less than 120 days remains to allow the overassessment. Appeals may accept such a case without a claim if the Appeals Area Director approves.

    2. Cases involving proposed overassessments exceeding $100,000, regardless of the time remaining in the limitation period for scheduling overassessments.

    3. Cases forwarded to the Headquarters Office, regardless of the amount of overassessment involved, if 30 days or less remain in the statutory period for scheduling overassessments.

  2. The number of cases requiring a claim invitation will be limited because the Service considers a waiver in the Form 870or Form 890series to be a valid claim for refund when the taxpayer agrees to an overassessment determined by the Service.

  3. When a taxpayer is invited to file a claim, a separate Letter 897should be sent for each taxable year needing protection.  (06-10-2005)
Application of Revenue Ruling 99-40

  1. There are certain periods of time when the Government retains the taxpayer’s money without paying for its use as required by the following:

    1. IRC § 6611(e)(1) prohibits the payment of credit interest to the taxpayer if an overpayment is refunded within 45 days of the receipt of an original return or a carryback claim. See IRM

    2. In regard to delinquent returns, IRC § 6611(b)(3) provides that no credit interest shall be allowed or paid for any day before the date on which the return is filed. See IRM

    3. Treas. Reg. § 301.6402-3(a)(5) provides that the allowance of interest is prohibited when an overpayment reported on a return or amended return is applied as a credit elect to estimated tax for the succeeding year.

  2. Examiners should insure proper calculation of interest when an original return had an overpayment and the taxpayer chose to elect to apply all or part of the overpayment shown by its return to its estimated tax for the succeeding tax year instead of taking a refund. Rev. Rul. 99-40, 1999-2 C.B. 441 held if an overpayment claimed on a return is credited to the succeeding year’s estimated tax, interest will be assessed on that portion of a subsequently determined deficiency for the overpayment return year that is less than or equal to the overpayments as of: (1) the date on which the Service refunds the overpayment without interest; or (2) the date on which overpayment is applied to the succeeding year’s estimated taxes. Any remaining portion of the deficiency will be assessed from the original due date of the tax for the overpayment return year. Potential Rev. Rul. 99-40, 1999-2 C.B. 441 cases are those with a TC 830 or TC 836 on the module. Case Processing generally will not apply the provisions of Rev. Rul. 99-40, 1999-2 C.B. 441 unless advised.

  3. The examiner should flag Form 3198 of the potential interest relief per Rev. Rul. 99-40, 1999-2 C.B. 441. The examiner should include Form 2220/Form 2210 (subsequent year) in the case file which provides a schedule of the required estimated tax payments for the succeeding tax year and the related transcripts.  (06-10-2005)
Deficiency Dividends

  1. The Internal Revenue Code provides a method under which a personal holding company may, under certain circumstances, be relieved from the payment of a liability of the tax imposed on personal holding companies.

  2. In any case in which a deficiency in personal holding company tax is disclosed to which the taxpayer agrees, the benefits afforded by IRC section 547 will be explained to the taxpayer, if applicable.  (08-11-2006)
Informal Agreements Under IRC Section 547(c)(3)

  1. If the taxpayer decides to make a distribution of earnings for the purpose of securing a credit against the liability, the taxpayer will be advised that the liability may be established by executing an informal agreement under IRC section 547(c)(3) on Form 2198,Determination of Liability for Personal Holding Company Tax, or by entering into a final closing agreement on Form 866.


    Use of Form 866is usually limited to litigated cases.

    1. Form 2198should not be accepted unless all items relating to the personal holding company tax liability and other income tax liabilities are agreed upon and a Form 870is signed by the taxpayer.

    2. Unless sufficient time remains in which to make an assessment under IRC section 6501,Form 2198or Form 866,Agreement as to Final Determination of Tax Liability, should not be approved. (In addition to the 120-day period for filing a Form 976,Claim for Deficiency Dividends Deduction, or Credit or Refund by a Personal Holding Company or Real Estate Investment Trust.)

    3. Form 2198may be approved if a consent is secured from the taxpayer under IRC section 6501(c)(4) to extend the statute. One year should remain on the statute when the case is closed to Technical Services (TS). See IRM

    4. Form 866– This form is not routinely used in lieu of Form 2198unless advised by Counsel for a unique situation. The examiner should consult with the Group Manager and local Counsel to determine if the use of a closing agreement is appropriate, and if so, which particular type should be used. If Form 866is used as the agreement document, the examiner will prepare the agreement and secure the taxpayer’s signature in accordance with the instructions in the Closing Agreement Manual, IRM 8.13.1. All closing agreements require local Counsel’s approval and Technical Services review before obtaining the taxpayer’s signature.

    5. Counsel Involvement - Coordination with local Counsel is required in the development of the closing agreement when a standard language or pattern agreement is not used and there are modifications to a pattern agreement. A review by Technical Services and the approval of local Counsel is required, relative to the language and form of the closing agreement, prior to securing the taxpayer’s signature. There must be sufficient documentation in the taxpayer’s administrative file to support Counsel’s concurrence. To request a review, a formal or informal correspondence should be addressed to local Counsel stating the reasons for and intent of the agreement and requesting review of and concurrence with the draft closing agreement. The correspondence may be in the form of an E-mail, fax, or memorandum. If needed, the Technical Services Closing Agreement Coordinator will prepare the request to Counsel. For technical assistance check the Compliance Field Operations Technical Services Program Assignment Directory at: http://sbse.web.irs.gov/compliance/About/directories/TechServProgAssign.asp

  2. Form 4549–Ais prepared reflecting the Personal Holding Tax as "Other Taxes" with an attached explanation. See Exhibit 4.10.8-5.

  3. Form 870,which is required to be submitted with Form 2198,should contain the following statements:

    1. The waiver of restrictions on assessment and collection contained herein is subject to the approval of Form 2198relating to the taxpayer’s liability for Income and Personal Holding Company Tax.

    2. This waiver will not take effect until after the expiration of the 120 day period to begin with the effective date of Form 2198.

    3. If the taxpayer complies with IRC section 547, relating to the payment of deficiency dividends, by (1) paying the deficiency dividends within 90 days after the effective date of Form 2198,and (2) filing a proper claim on Form 976subsequent to the payment of the deficiency dividends and within 120 days after the effective date of Form 2198,then the amount of the deficiency stated on this waiver shall be reduced by the amount necessary to give effect to the timely paid deficiency dividends, and the remainder, if any, will be assessed.

    4. If, at the expiration of the 120 day period beginning with the effective date of the Form 2198,a Form 976has not been filed or timely deficiency dividend payments have not been made, the entire amount of the deficiency shown in this waiver will be assessed.

    5. See Exhibit 4.10.8-6.

  4. Upon Receipt of Form 2198:

    1. The original Form 2198should be initialed by the examiner and group manager to indicate their acceptance of the form.

    2. The original Form 2198should be attached to the return for the last taxable year covered by the agreement.

    3. A duplicate Form 2198will be mailed to the taxpayer with Letter 1152using certified or registered mail within 5 calendar days.


      Treas. Reg. § 1.547–2(b)(1)(v) provides that, with one exception, the date of determination is the date the signed agreement (Form 2198) is mailed to the taxpayer and not the date the agreement is signed by the authorized Service official.

    4. See Exhibit 4.10.8–7 for a Sample Form 2198.

  5. After accepting Form 2198,the case should be held in suspense by Technical Services (TS) until Form 976is filed or the expiration of the 120 day period, whichever is earlier. The case should then be returned to the examiner.  (06-10-2005)
Receipt of Claim: Form 976

  1. The date on which Form 976is filed in accordance with applicable regulations will be the controlling date to determine whether the form has been timely filed. The effective date of an informal agreement on Form 2198,Determination of Liability for Personal Holding Company Tax, will be the date the signed agreement is mailed to the taxpayer.

    1. FORM 976, Filed Timely — the examiner will verify the information on Form 976to the extent deemed necessary and then prepare a report of the examination showing the general adjustments, the personal holding company income, the reduction due to the allowance of any deficiency dividend deduction, and whether the amount of the claim (Form 976) was allowed in full, allowed in part, or disallowed in full. See Exhibit 4.10.8-8.

    2. FORM 976, Not Filed Timely — a letter will be sent to the taxpayer as notification that the claim was not timely filed. A certified notice of disallowance will be issued unless the taxpayer has signed Form 2297,Waiver of Statutory Notice of Claim Disallowance. See IRM  (06-10-2005)
Appeals Cases: Area Compliance Responsibilities

  1. When Appeals accepts a Form 2198, the Appeals Officer solicits the taxpayer’s claim (Form 976) and secures supporting evidence from the taxpayer.

    1. The Appeals Officer may prepare the report and close the case if there are no unusual circumstances and verification of payment of the deficiency dividends can be made easily.

    2. The Appeals Officer may return the case to the Examination field group. The case should be assigned to an examiner to verify payment of the deficiency dividends and prepare the report. The report should include adjustments made by Appeals. The report should be returned to Appeals for closing. If the examiner determines that the claim was not timely filed, the case should be returned to Appeals without contacting the taxpayer.  (08-11-2006)
United States Tax Court Cases: Area Compliance Responsibilities

  1. In cases where the liability for personal holding company tax has been established by a decision of the United States Tax Court, Appeals will assess the gross deficiency. The Appeals Officer will explain to the taxpayer the actions to be taken to assess the tax and how to secure the benefits of IRC section 547.After the assessment has been made, the administrative file will be forwarded to the Area Compliance Examination. See IRM,Docketed Personal Holding Company Tax Cases.

  2. The case will be held in suspense (Technical Services) until a Form 976is filed or until the expiration of the 120 day period for filing Form 976,whichever is earlier.

  3. If a Form 976is not timely filed, the case will be transferred for collection action, consistent with the Court’s decision.

  4. If a Form 976is timely filed, the case will be assigned to an examiner.

    1. Upon receipt of a closing agreement from the taxpayer, Form 866will be prepared and forwarded to Technical Services (TS) for processing. The date of the closing agreement on Form 866will be the date upon which the closing agreement is signed by the Area Director. The closing agreement, together with the case file, will be transmitted to the Area Director for approval.

    2. Once approved, Technical Services (TS) will determine any need for follow-up action and transmit a copy of the closing agreement to the taxpayer.  (06-10-2005)
Closing Procedures For All Dividend Deficiency Cases

  1. For all cases where a deficiency dividend deduction is allowed, the examiner will prepare Form 3189,Deficiency Dividend Case Transmittal. See Exhibit 4.10.8-9.

    1. The form will include a computation of the tax liability before the reduction for payment of deficiency dividends. This is necessary for computing the interest amount.

    2. The original Form 3189will be placed on top (outside) of the case file.

    3. A duplicate Form 3189will be attached to every corporation return for which a deficiency dividend was paid.

  2. If a return for which deficiency dividends were paid has not yet been filed, then the examiner should prepare Form 5346, Examination Information Report, and attach the duplicate Form 3189so that it can be associated upon filing.

  3. Form 5346,Examination Information Report, should be completed to report dividends paid to shareholders in the current year.

  4. Form 3198should identify the case as a restricted interest and claim for deficiency dividends paid case.  (08-11-2006)
Unagreed Case Procedures: Preliminary (30-Day) Letters

  1. Preliminary (30-day) Letters are used to furnish taxpayers a copy of the examination report and advise them of their appeal rights when they do not agree with the results of an examination. Refer to Statement of Procedural Rules § 601.105(d) - Thirty-day letters and protests for legal authority and additional explanation. Generally, the 30-day letters are:

    1. Office examination - Letter 915(issued with first report)

    2. Field examination - Letter 950

    3. Transferee / Transferor Cases - Letter 955.See IRM, Transferor-Transferee Liability Cases.


    Treasury has not yet amended Statement of Procedural Rules § 601.105 to reflect changes made by the "Community Renewal Tax Relief Act of 2000," P.L. 106–554.

  2. Preliminary (30-day) Letter procedures are applicable to income, estate, gift, excise, and employment tax cases.

  3. Per Appeals IRM, 180 days must be remaining on the statute when they receive the case. The group should consider a minimum of 30 days for processing in consideration of the statute requirements.

  4. Managerial involvement is required in unagreed cases. A field group preliminary (30-day) letter generally should not be issued to the taxpayer unless the manager has contacted the taxpayer and/or representative to attempt to resolve the tax controversies and reach an agreement. If the case is a no-show/no-response case, the manager will verify that an address confirmation was done. These efforts will be documented in the case file. Form 9984,Examining Officer Activity Record, or Form 10118,Supervisory Conference - Unagreed Cases, or Form 10307, Unagreed Office Audit Cases, may be used for this purpose.

  5. On all unagreed cases, SB/SE examiners must inform the taxpayer about the Fast Track Mediation (FTM) program, provide a copy of Publication 3605,Fast Track Mediation a Process for Prompt Resolution of Tax Issues, to the taxpayer, and offer the taxpayer an opportunity to use FTM if they meet the criteria. FTM is optional and represents an expansion of the taxpayer's dispute resolution options. FTM does not eliminate or replace a taxpayer's right to request the Appeals Office and/or a court to review a case. See IRM, Issue Resolution, for more information on SB/SE Fast Track Mediation procedures and references.

  6. Fast Track Settlement (FTS) is available on LMSB cases. FTS may be initiated at any time after an issue has been fully developed. See IRM 4.51.4,LMSB/Appeals Fast Track Settlement Program (FTS) for more information.

  7. Letters are issued in change cases and in no-change cases involving the disallowance in full of claims for refund. Exceptions are fraud cases involving criminal prosecution and frivolous filers/nonfilers when Appeals does not have jurisdiction for these cases.

  8. If an examination of a return results in a deficiency or overassessment that is offset (no deficiency or overassessment results) by a net operating loss carryback, a computation of restricted interest may be required. If the taxpayer disagrees with the examination results, they will be afforded the same opportunity to request an Appeals hearing, as if a deficiency/overassessment were involved.

  9. IRC section 6651(f), Fraudulent Failure to File (FFTF) Cases — The portion of a FFTF penalty attributable to the amount of tax shown on a return is assessable immediately and is not subject to deficiency procedures. To ensure that the facts of a particular case support fraud, and because the assessment of a FFTF penalty attributable to the amount shown on a return will not be reviewed by the Tax Court, all 30-day letters proposing a FFTF penalty must be reviewed and approved by Area Counsel prior to issuance. Furthermore, the period of limitations on assessment of such portion would not be suspended by the issuance of a notice for the other portion.  (06-10-2005)

  1. Report forms used to present the audit findings for an unagreed case are similar to those used for agreed cases and the instructions for completing agreed case reports generally apply. However, these unagreed report forms do not include a signature line for the taxpayer’s consent to assessment and collection. Unagreed cases are "excepted" agreed cases. See IRM above for instructions for preparing waivers ( Form 870- Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment). Also, there is no statement regarding the Area Director’s acceptance of the report.

  2. The following report forms are used for unagreed cases.


    Use of Form 4549–Ais optional for Office Examination in lieu of Form 4549.

    Type of Taxpayer Report Form Agreement Form (Waiver)
    Individual (1040) 4549–A 870
    Corporations (1120) 4549–A 870
    Non-TEFRA Partnerships (1065) 4605–A
    Non-TEFRA S-Corporations 4605–A,
    870 (entity tax)
    Fiduciary 4605–A
    Domestic International Sales Corporations 4605–A
    870  (08-11-2006)
Separate Assessments on Joint Taxpayers

  1. In certain cases, it may be necessary to set up separate assessments for taxpayers who filed a joint return. For example, when only one spouse signs an agreement and the deficiency is not fully paid, an assessment may need to be made on the agreeing, or "obligated" spouse in order to protect the statute of limitations for that taxpayer while unagreed procedures are applied to the other spouse. Similarly, a separate assessment would need to be made when only one spouse does not petition Tax Court after receiving a 90-day letter. In these situations, separate assessments are made using MFT 31, as long as the SSN's are valid (no asterisks). If invalid, Non-Master File procedures found in IRM 21.7.12and IRM 3.17.46will apply.

  2. Although an assessment will be made on the obligated spouse, no collection notices will be mailed until the case is ultimately resolved (and assessment adjusted if necessary). At that time, an MFT 31 assessment will be set up for the other spouse.

  3. If only one spouse signs an adequate protest requesting Appeals consideration and no response is received from the other spouse, the case will normally be sent to Appeals as long as there is sufficient time on the statute of limitations for both spouses. In other words, one signature on the protest may be adequate.

  4. However, if one spouse agrees and one protests, a separate assessment may be necessary on the obligated spouse especially if the statute of limitations for that spouse is imminent. In any event, note on the Form 3198 that one spouse has signed a waiver, so Case Processing can calculate interest accordingly.

  5. If one spouse agrees and the other does not respond to the 30-day letter, a separate assessment needs to be set up on the obligated spouse before the case is sent to Technical Services for 90-day letter procedures.

  6. Procedures for creating an MFT 31 account:

    1. Request the creation of the MFT 31 account for the obligated spouse by preparing Form 3177.The top section of Form 3177will be completed, using the primary SSN .

    2. In the "Other" section, put TC 971 in the empty box, and on the line state "Action Code 102" (Action Code 103 is used if both spouses are unagreed but only one petitions the Tax Court after receiving a 90-day letter). Also on the "Other" line the obligated (agreeing) spouse's SSN is noted as the "XREF SSN: XXX-XX-XXXX."

    3. Complete the MFT Code (30) and the taxable period (a separate Form 3177is needed for each year). The TC 971 and appropriate action code on the MFT 30 account will create an MFT 31 account for the XREF SSN listed.

  7. Send or fax the Form 3177to Case Processing / FORT manager and request a partial assessment be made on the obligated spouse:

    1. Forms 3198, 5344 & RAR are needed in addition to the Form 3177.

    2. Note on Form 3198 "input TC 971 per attached Form 3177. " Include your name and fax number so Case Processing can fax you a copy of Form 5344 after the partial assessment has been made.

    3. Form 5344 will show MFT 30 and the primary SSN. In the top left of the 5344 put an "S" in the blank following AMCLS. In Item 56 put either "P" or "S" depending on whether the assessment is being made on the primary or secondary spouse. This is a manual input, so if RGS won't print the 5344 with this information, it can be hand written on the form.

    4. Send or fax these forms to your Case Processing / FORT manager, while you continue to hold the case.

  8. Continue normal unagreed procedures for the disagreeing/petitioning spouse. Associate an IMFOLT and / or copy of the Form 5344 received from Case Processing showing that the partial assessment on the other spouse has been made on MFT 31. Close the case as you normally would (including RGS LAN), but note on the Form 3198 that Manual Closure is required due to MFT 31 assessments.

  9. Examiners may refer to IRM 21.6.8,Split Spousal Assessments (MFT 31) for additional information.  (08-11-2006)
Explanation of Items

  1. A copy of the examiner’s lead sheet relating to each adjusted issue will be attached to the report form to explain the adjusted items. A separate lead sheet should be used for each adjustment. If the adjustment is applicable to more than one year, the adjustments should be shown on one combined lead sheet.

  2. The following format should be used for Field Examination cases:

    1. Title — Each lead sheet should be numbered and titled to correspond with the adjustment on the audit report. See IRM The lead sheet should reflect the amount per return, the amount per audit, and the resulting adjustment.

    2. Facts — Each lead sheet will include a statement of the facts upon which the adjustment is based. The statement should be in narrative form. The facts must be relevant to the issue and should be stated accurately and objectively. Facts favorable to both the Service’s and taxpayer’s position must be included.

    3. Applicable Law — The applicable authority should be correctly cited and explained (if necessary). Rulings, opinions, and decisions relied upon are to be clearly stated and identified in the explanation. Citations are not required when the adjustment is predicated entirely on facts, or when they serve no useful purpose. However, reports should be informative for the taxpayer.

    4. Taxpayer’s Position — The taxpayer’s position should be stated (in narrative form) if known. The legal authority, if any, that the taxpayer is using as the basis of their argument should also be cited. If the taxpayer has provided a written position statement, include the entire statement in this section or summarize the statement and include the entire document in the report as an exhibit.

    5. Argument — Relate the facts, as previously stated, to the cited authority through a narrative discussion to support the Service’s position. Also include the Service’s refutation of the taxpayer’s position. The examiner’s argument will be included in the new law section of the applicable issue lead sheet. See IRM

    6. Conclusion — Briefly state a conclusion of the Service’s position.

  3. The copy of each issue lead sheet that is used as an attachment to the examination report may be modified to remove extraneous information (e.g., work paper cross-referencing, audit steps that were not employed during the audit, etc.) that would be of no use to the taxpayer or representative.  (06-10-2005)
Alternative Positions

  1. An alternative position for an issue in an unagreed case is a secondary position that the Service may ultimately rely on if the primary position cannot be upheld. An alternative position is recommended as Appeals generally will not raise new issues. Therefore, the examiner must outline all alternative positions that may be applicable if the primary position is not sustained.

  2. The primary and secondary positions will usually address a different set of law and arguments. Due to this, the tax computation for the alternative position may be different from the primary position.

  3. An alternative position should be used for tax law that supports two totally separate positions. For example, when an adjustment is proposed to disallow business expenses due to IRC section 183, hobby loss provisions; the IRC section 162 adjustment should be written up as an alternative position to IRC section 183. The primary position should be the larger of the liabilities when two positions are considered.

  4. An alternative position is not required for an adjustment that is supported by multiple code sections of tax law for one position. For example, to support a disallowance of business expenses, IRC section 162(a), ordinary and necessary business expenses, and IRC section 6001, lack of substantiation, may be incorporated into one explanation of adjustment.  (06-10-2005)
Reports for Alternative Positions

  1. The alternative position must be discussed with the taxpayer, or his/her authorized representative prior to issuing the examination report. The alternative position report must be included in the report presented to the taxpayer.

  2. The facts, law, taxpayer’s position, and conclusions for the alternative position on an issue will be presented on a separate lead sheet from the primary position.

  3. If the tax computation changes due to the alternative position, a separate Form 4549–A,Income Tax Examination Changes, from the primary position will be prepared in addition to a separate lead sheet.

  4. The top of each of these report forms for the alternative position will be marked "ALTERNATIVE ISSUES."

  5. The alternative position report will be placed behind the report containing the primary position.

  6. For unagreed cases that contain multiple related issues it will not be necessary to prepare an alternative tax computation on Form 4549–Afor each combination of alternative issues. Form 4549–Aand appropriate lead sheets will be prepared for the primary issues. However, only lead sheets will be prepared for the alternative issues.

  7. If a partial agreement is being solicited in conjunction with a correlative (i.e. whipsaw) adjustment and the taxpayer wants to agree with the non-correlative adjustment(s) secure Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency In Tax and Acceptance of Overassessments. Form 870must specifically state that the correlative adjustment(s) is/are not shown in the computation of the deficiency or overassessment.

  8. Backup withholding is a strong alternative position in a case where an Employer did not issue Form 1099and did not get TIN’s from the workers. Procedures for backup withholding can be found in IRM

  9. The negligence/substantial understatement portion of the accuracy related penalty is the standard alternative position when asserting the Fraud Penalty.

  10. The failure to file penalty (FTF) is the standard alternative position to the fraudulent failure to file penalty (FFTF).

  11. When the accuracy-related penalty attributable to a substantial understatement of income tax is not asserted due to the assertion of negligence or disregard of the rules or regulations, an unagreed report will include the substantial understatement as an alternative position.  (08-11-2006)
References - Alternative Position in Unagreed Cases

  1. References for Alternative Position in Unagreed Cases:

    • IRM Finalizing Penalty Determinations

    • IRM Alternative Positions

    • IRM Alternative Position in Unagreed Case Employment Tax Reports

    • IRM Common Features: Accuracy-Related and Civil Fraud Penalties

    • IRM Preparation of Pre-Prosecution Report  (08-11-2006)
Form Letters

  1. Generally, Preliminary (30-day) Letters allow the taxpayer 30 days to request Appeals consideration of their case. The following form letters, specific to the type of case, are used for this purpose:

    1. Letter 950(DO) — for straight deficiency, straight overassessment, or mixed deficiency and overassessment field examination cases;

    2. Letter 915(DO) — for straight deficiency, straight overassessment, or mixed deficiency and overassessment office examination cases;

    3. Letter 569(DO) — for claim disallowance cases;

    4. Letter 953(DO) — for reconsideration of disallowed claims when no modification of prior determination is warranted;

    5. Letter 962(DO) — for straight deficiency, straight overassessment, or mixed deficiency and overassessment fiduciary cases;

    6. Letter 921(DO) — for flow-through entities (partnerships, fiduciaries, S-corporations, etc.);

    7. Letter 3391(DO) — for nonfilers;

    8. Letter 1125(DO) — for preparer penalty cases; and

    9. Restricted Interest Cases — the examiner will need to prepare and the manager approve a letter patterned after the form letters listed in a–h above. No form letter is available due to infrequent use. The letter should address the restricted interest issue, rather than a deficiency or overassessment of tax.  (08-11-2006)
Report Transmittal: Form 4665

  1. This form is used to summarize unagreed issues and present information of a confidential nature for Appeals. The information should supplement, not duplicate or replace, information in the case file. On field cases, this form is used in conjunction with Form 9984to document managerial involvement.

  2. Confidential information included on the report transmittal includes:

    1. Statements and facts involving allegations of fraud;

    2. Remarks regarding the integrity, motives, or abilities of the taxpayer;

    3. Ability to pay;

    4. Potentially dangerous taxpayers;

    5. Procrastination by the taxpayer or representative;

    6. Other confidential information which should not be made available to the taxpayer.

  3. Items which need safeguarding from disclosure with Document 6441should not be included or referenced on the report transmittal. Examples include fraud referrals and identification of informants.  (06-10-2005)
Contents of Preliminary (30-Day) Letters

  1. Preliminary (30-day) Letters will include the following documents:

    1. Appropriate form letter;

    2. Examination report and waiver;

    3. Publication 3498,The Examination Process (or Publications 1, 5, and 594).


      Publication 3498 must always be enclosed with the preliminary (30-day) letter even if it was provided with a previous report or letter.  (08-11-2006)
Mailing Preliminary (30-Day) Letters

  1. Preliminary letters will be sent by ordinary mail unless it is considered necessary to document the mailing and delivery. In such cases, certified or registered mail should be used and a return receipt requested.

  2. Preliminary (30-Day) Letters should be prepared by the examiner, and could include the examiner’s name or group manager’s name, as the situation warrants, in the contact area of the letter.

  3. The authority to sign and issue the letters is delegated to group managers.

  4. In the case of a joint return, a complete original Preliminary Letter will be sent to each spouse.

  5. A copy of the Preliminary Letter, with all enclosures, should be sent to the taxpayer’s representative if authorized to receive such communication.

  6. A copy of the Preliminary Letter will be maintained in the case file.

  7. After mailing the Preliminary Letter, the case will be held in the group’s suspense files. Managers will ensure adequate controls for cases in 30-day status.  (08-11-2006)
Extension of Time to Respond

  1. In general, Statement of Procedural Rules § 601.105(d)1, does not provide for any extension of time to reply to Preliminary (30-day) Letters. However, as a matter of practice, extensions may be granted under reasonable circumstances.

  2. Reasonable circumstances include but are not limited to the following:

    1. The taxpayer retains a representative and demonstrates a need for more time to prepare a meaningful protest,

    2. The taxpayer retains a new representative,

    3. Sickness or injury of the taxpayer or representative, or

    4. Issues are complex and require extensive research.

  3. Requests for extensions should be in writing and should state the reason(s) why additional time is needed. Since many requests are made by telephone, the extension may be granted verbally and confirmed in writing upon receipt of the written request.

  4. Extensions should not be granted if the statute of limitations will expire within 240 days and the granting of an extension will not leave sufficient time to process the case. Under such circumstances an extension to respond to a Preliminary Letter will be contingent upon securing an extension of the statute of limitations.

  5. Extensions are granted by the group manager or a designated management official. The taxpayer should be notified in writing of the extension and the specific extended response date. Letter 686, Extension of Time for Certain Actions, will be used for this purpose. Extensions are normally granted for no more than 30 days unless a specific reason supports additional time.

  6. If the taxpayer lives outside of the United States, the 30-day letter can be modified to allow for a reasonable period of time to respond.

  7. If an examination report is changed after a 30-day letter has been issued, follow Corrected Report procedures and solicit an agreement. If the taxpayer does not agree to the corrected report, take the following steps, as appropriate:

    • If the corrected report reduces the previous RAR and no new issues are raised, the case can be closed after the initial 30 days have expired. No new 30-day letter is needed.

    • If the corrected report raises new issue(s) or the proposed deficiency is increased, a new 30-day letter will be issued, if sufficient time remains on the statute of limitations.  (08-11-2006)
Response to Preliminary (30-Day) Letters

  1. If a signed agreement form (or full payment not designated as a "6603 deposit") is received in response to the Preliminary Letter, the case will be closed from the group within 10 days from the date the report is received using agreed case closing procedures.

  2. If the taxpayer indicates agreement to part of the report, solicit a partial agreement. If a partial agreement is received, process according to See IRM The case will remain in 30-day suspense awaiting either a protest or default for the remaining issues.

  3. If a waiver is not signed, but a partial remittance is received (not specifically designated as a deposit in the nature of a "6603 deposit") the payment will not be treated as a partial payment of tax unless the taxpayer designates it as such.

    1. Contact the taxpayer by phone to ask whether the payment was intended to be a payment of tax or a "6603 deposit". Document the conversation in the case file. If the taxpayer cannot be reached, draft a follow-up letter. The letter will inform the taxpayer that
      — We received the remittance.
      — We did not receive a protest or a signed waiver agreeing to adjustments.
      — We need to know whether they intended the remittance to be a payment of the tax deficiency or a "6603 deposit".
      — We need to receive a response within 15 days from the date of the letter or the case will be routed for issuance of a Notice of Deficiency.

    2. If the taxpayer was contacted and agrees with all adjustments but could not pay the entire liability at the time and intended the remittance to be a partial payment, have the taxpayer sign the waiver and determine if the taxpayer is eligible for an installment agreement. Process the payment as a partial payment. Do not hold the payment until the waiver is received.

    3. If the payment was intended to be a "6603 deposit", advise the taxpayer that if we don’t receive a protest or signed waiver, a Notice of Deficiency will be issued.

  4. The taxpayer may respond by requesting an appeal. The appeal request procedure below applies to Field Assistance as well as to Field/Office Examination.

  5. Appeal Request — Field/Office Examinations

    1. For any case where the total amount of proposed additional tax, additions to tax and penalties, proposed overassessment, or claimed refund, credit, or abatement for any tax period, does not exceed $50,000, a request for an appeal is made using small case procedures. These procedures require a written request asking for Appeals consideration, indicating the changes the taxpayer does not agree with and any reasons for disagreement.

    2. A case with a deficiency exceeding $50,000 requires a formal written protest.

  6. If the taxpayer submits a formal written protest it will be reviewed at the group level, as designated by management, within seven days of receipt to determine whether:

    1. The protest is adequate,

    2. The case requires further development by the examiner,

    3. The examiner’s report should be modified,

    4. The taxpayer’s written protest includes the required documents.

  7. A taxpayer’s formal written protest must include the following:

    1. A statement that the taxpayer wants to appeal the examiner’s findings to the Appeals Office;

    2. The taxpayer’s name and address and daytime telephone number;

    3. A copy of the letter showing the proposed changes and findings being protested or the date and symbols from the letter;

    4. The tax periods or years involved;

    5. An itemized schedule of the adjustments with which the taxpayer does not agree;

    6. A statement of facts supporting the taxpayer’s position on any contested factual issue;

    7. A statement outlining the law or other authority, if any, upon which the taxpayer is relying; and

    8. A declaration of truth for item " f" above under penalties of perjury. This may be done by adding the following signed declaration to the protest document:
      "Under penalties of perjury, I declare that I have examined the statement of facts stated in this protest, including any accompanying documents and, to the best of my knowledge and belief, they are true, correct, and complete."

  8. If the taxpayer’s representative submits the protest for the taxpayer, the representative may include a substitute for the taxpayer’s declaration described in paragraph (5)h above. The declaration will state:

    1. The representative prepared the protest and accompanying documents; and

    2. Whether the representative knows personally that the facts contained in the protest and accompanying documents are true and correct.

  9. The protest should be returned to the taxpayer if incomplete and additional time granted to perfect the document. The signature of only one spouse on a protest regarding a joint return does not make the protest inadequate.

  10. The case should be returned to the examiner for further development if the protest contains information warranting consideration. Cases returned for additional development should be considered priority work and given expedited consideration. If the examiner or group manager feels that there is something in the protest that does not change the determination, but requires further comment or explanation and is not confidential in nature, a rebuttal can be prepared and included in the case file before it is sent to Appeals. If a rebuttal is prepared, a copy should also be provided to the taxpayer.

  11. The group manager should attempt to discuss the disputed issues with the taxpayer (representative) in an attempt to resolve the issues, obtain agreement, and limit taxpayer burden. If agreement cannot be reached, the case will be forwarded to Appeals.

  12. If the taxpayer verbally requests a transfer of jurisdiction for the appeal, and the written protest is complete, the case file will be sent promptly to the local Appeals office serving the transferor's area. This procedure applies even if the taxpayer has requested a hearing in an Appeals office other than the one servicing the transferor's area.

  13. The fact that a Statutory Notice of Deficiency has been issued to the taxpayer does not preclude transfer of protested cases to Appeals for:

    1. Other taxable periods of the same taxpayer,

    2. Other types of tax for the same taxable periods for the same taxpayer, or

    3. An offer in compromise covering the same type of tax and the same taxable periods of the taxpayer.

  14. Appeals may also request jurisdiction of cases related to the cases described in (11) above.

  15. A case can be transferred to Appeals with a copy of the taxpayer’s return if:

    1. A transcript of account is attached to the duplicate return; and

    2. The case does not involve fraud, a jeopardy assessment, a Joint Committee case, or a Statutory Notice of Deficiency issued as a basis for closing.

  16. Requests from Appeals for additional information or further verification of facts in a protested case will be completed expeditiously.  (08-11-2006)
Follow-Up to Preliminary (30-Day) Letters

  1. FIELD EXAMINATION — If the taxpayer has not filed a protest within the time allowed, but indicated their intent to do so, Letter 923will be sent to the taxpayer to allow an additional 15 days to file a protest. Letter 923should be issued no later than seven calendar days after expiration of the original Preliminary Letter.

  2. OFFICE EXAMINATION/FIELD ASSISTANCE — If the taxpayer does not respond to the preliminary letter, Letter 2304 must be sent as a follow-up. Letter 2304should be sent 15 days after Letter 915(DO).

  3. If the Preliminary Letter is returned as undeliverable to the address on file, then an attempt will be made to obtain the correct address.

    1. If the taxpayer’s correct address is determined, the Preliminary Letter will be mailed to the new address. The period in which the taxpayer may reply starts with the date the letter was mailed to the new address.

    2. If the taxpayer’s correct address cannot be determined, then the case will be processed as outlined in below.

  4. If the Preliminary Letter proposes an overassessment or disallowance of a claim with no change in tax liability, no follow-up action should be taken. The case should be closed as outlined in IRM below.

  5. If no response to a follow-up letter is received, the case will be processed as outlined in IRM below.  (08-11-2006)
No Response to Preliminary (30-Day) Letter

  1. Cases will be closed from the group promptly within twenty days after the expiration of the time (including extensions) allowed to file a protest.

  2. DEFICIENCY CASES — A Statutory Notice of Deficiency will be prepared by Technical Services and issued when no response was received to the preliminary (30-day) letter subject to the following conditions:

    1. It appears reasonable that the taxpayer or authorized representative received the Preliminary (30-day) Letter or, if not received, the Service exercised due diligence in determining the taxpayer’s last known address.

    2. The taxpayer is temporarily away and is not expected to return within a reasonable period of time, or has not returned after a reasonable extension has been granted.

    3. Follow-up action was taken without success.

    4. The notification required by IRC § 534(b), cases involving alleged unreasonable accumulation of earning and profits, has been issued.


    See IRM examination group instructions.

  3. Regardless of the conditions outlined in paragraph (2) above, a statutory notice of deficiency will be issued within the time fixed by law if the statute of limitations will expire within 150 days and the taxpayer will not execute a consent to extend the statute of limitations period. See IRM

  4. OVERASSESSMENT PROPOSED — If the taxpayer fails to reply to a preliminary letter advising of a proposed overassessment (adjustments that decrease the tax liability exceed the adjustments increasing the tax liability), the case will be closed out of the group to Case Processing for assessment of the overassessment.

  5. CLAIM DISALLOWANCE — If the taxpayer fails to respond to the preliminary letter advising them of the disallowance of the claim, a Notice of Claim Disallowance will be issued by Technical Services.

    1. If there is no change to the tax liability (neither a deficiency or overassessment), indicate on Form 3198, "Issue Letter 906,Notice of Claim Disallowance – Full, enclosed inside the case file."

    2. If the claim is disallowed in part with a resulting overassessment, indicate on Form 3198," Letter 905,Notice of Claim Disallowance – Partial, enclosed inside the case file."

    3. Both letters include several lines for the examiner to insert the reasons for disallowance. Complete the letter except for the date, include the reasons for disallowance, and place the letter inside the case file on the top.

  6. EMPLOYMENT TAX CASES — A Preliminary (30-day) Letter will be issued in employment tax cases to advise taxpayers of all unagreed proposed adjustments to their tax liabilities and of conclusions reached in no-change cases involving the disallowance in full of claims for refund. Generally, if a valid protest is not received for an employment tax case, it is closed without issuance of a statutory notice of deficiency. However, for certain worker classification issues or Section 530 relief issues, a Notice of Determination of Worker Classification ( Letter 3523) is necessary. Examiners should refer to IRM for additional information.

  7. RESTRICTED INTEREST CASES — If the taxpayer fails to reply to the special letter within the time allowed, the tax liability will be adjusted as proposed in the examination report. See AIMS Processing Procedures in IRM 4.4.1 for more information regarding restricted interest assessment.  (06-10-2005)
Time Reporting for Preliminary (30-Day) Letters

  1. Time spent by examiners to prepare the unagreed report and accompanying explanatory lead sheets is charged to the case under Direct Examination Time (DET).

  2. Time spent by examiners on 30-day letter activities (including preparation of the 30-day cover letter, protest reviews, and follow-up letter) will be reported using non-examination Activity Code 646. Preparation of the report (including RAR and explanatory lead sheets) is not reported under Activity Code 646. When 30 day activity begins, the case should be removed from the agent’s inventory and kept in the manager's office.

  3. The case should be updated to Status Code 13 on AIMS when the Preliminary Letter is sent to the taxpayer from the group. If the Preliminary Letter is sent from Technical Services, the case will be updated to Status Code 22.

    1. AIMS Statute Table 4.1, at the group level, will include cases in Status Codes 9–18.

    2. AIMS Table 4.0, for Technical Services Staffs, will include cases in Status Code 22.

  4. If further development is required after the Preliminary Letter activities have begun, the case will be returned to the examiner and reactivated under Direct Examination Time, Status Code 12.  (08-11-2006)
Corrected Reports

  1. This section includes instructions for correcting reports which include errors. Revisions to reports are considered "corrected reports " when changes are made to reports issued with 30-day letters or to reports which have been signed by the taxpayer. Reports which are revised due to additional information provided during the examination (before a 30-day letter or agreement) should be retained in the workpapers. If a closing letter (such as Letter 590or Letter 987) has been sent to the taxpayer, re-opening procedures must be followed. See IRM

  2. Signed waiver and the error is in the taxpayer's favor. If an error was made in computing a deficiency, overassessment or penalty shown on a previously executed report/waiver that is in the taxpayer's favor, a corrected report will be prepared. A copy should be given to the taxpayer; however, no signature on the new report/waiver is required. Note on the corrected report, "Refer to the taxpayer's signature on the report dated (date)."

  3. Signed waiver and the error is NOT in the taxpayer's favor. If an error is against a taxpayer (more tax due or less refund), the examiner has two alternatives. First, the examiner may prepare a corrected report and solicit a new waiver. Or, the case may be processed for the amount shown on the original executed report/waiver if it falls under the Error Tolerance levels of SB/SE Delegation Order 4.41. The group, or function discovering the error, will prepare a memo to Case Processing signed by a person authorized by the delegation order.

    Amount of Error Authority to Sign
    1. $500 or less per tax year RAs, TAs, TCOs, Reviewers, TEs in Case Processing and Technical Services
    2. $5,000 or less per tax year Technical Services Group Managers and Compliance Territory Managers
    3. $10,000 or less per year Technical Services Manager and Compliance Territory Managers
    4. Exceeds $10,000 per year Area Director and Technical Services Territory Managers

  4. A corrected report should be prepared as follows:

    1. Across the top of the corrected report write "Corrected Report."

    2. In the other information or remarks section write, "This report supersedes report dated (date). "

    3. The taxpayer’s signature is only required on the corrected report if the change is in the government’s favor, i.e., more tax or less refund. If the taxpayer disagrees with the corrected report, unagreed procedures are applicable. Consider each year separately with no netting of tax periods. New waivers may need to be solicited even though the net effect of the corrections may be in favor of the taxpayer.

  5. The original report will be noted across the top, "This report superseded by report dated (date)."

  6. Both the original and corrected reports are included in the case file.

  7. Note on Form 3198, Special Handling Notice / Examination Case Processing, " Corrected Report."  (05-14-1999)
Issues Requiring Special Reports and Forms

  1. This section includes examination issues which require computations on a standard form. When an adjustment is proposed in any of these areas, the applicable form should be completed and attached to the examination report to clarify how the adjustment was determined.  (08-11-2006)

  1. Use Form 1914,Computation of Allowable MACRS/ACRS/Depreciation Deduction, to compute allowable depreciation expenses.  (06-10-2005)
Passive Activity Loss Limitations

  1. Worksheets should be provided to the taxpayer in cases in which the passive loss, the allowed loss and the disallowed (suspended, carryover) loss must be allocated among the various passive activities so the activities can be properly reported in subsequent years.  (08-11-2006)
Adjustments to Net Operating Loss (NOL)

  1. Any adjustment to a net operating loss deduction should be completely explained in the report. The adjustment on Form 4549 should be identified as a NOL carryback with source year identified or NOL carryforward with source year identified.

  2. Examiners should refer to IRM 4.11.11,Net Operating Loss Cases, when making adjustments to net operating losses.

  3. Examiners should be aware that Net Operating Loss deductions may result in Joint Committee jurisdiction. See IRM 4.36.2,Identification of Joint Committee Cases.

  4. Examiners should also note that Net Operating Loss deductions usually require restricted interest computations. For examination procedures on these cases, See IRM Restricted Interest.  (08-11-2006)
Computation of the Net Operating Loss

  1. A report which proposes an adjustment to a net operating loss deduction should include all computations necessary to fully explain the source year and amount of any net operating losses.

  2. The computation will include the modifications required by IRC § 172(d).

  3. Form 3621,Net Operating Loss Computation, may be used for this computation.

  4. Corporate NOL and individual NOL worksheets may be found at "http://rgs.msr.irs.gov/users/downloads/downloads.htm" under "Special Applications."  (08-11-2006)
Computation of the Net Operating Loss Deduction

  1. The report should include a computation of the amount of the net operating loss allowable in any year.

  2. The computation will include the loss modifications required by IRC § 172(b)(2).

  3. Form 3621–A,Computation of a Net Operating Loss Deduction for Intervening Years Modifications, may be used for this computation.  (08-11-2006)
Reports After a Tentative Refund or Credit

  1. IRC section 6411 allows the taxpayer to apply for refund or credit using Form 1045(for individuals) or Form 1139(for corporations); the adjustment to the tax is not a claim. Examiners should be aware that tentative allowances are special restricted interest cases. The campus computes and pays restricted interest when the tentative refund is processed. See IRM The examination report reflecting a tentative allowance of a refund or credit is explained below.

  2. ADJUSTMENT OF THE NET OPERATING LOSS DEDUCTION (NOLD) — The report should show the correct NOLD amount. If the NOLD is allowed in full, the entire NOLD would be shown as an adjustment. If the NOLD is not allowed, the adjustment on the report would be zero.

  3. TAXABLE INCOME AS SHOWN ON THE REPORT — The taxable income per return (or as previously adjusted) is the amount prior to the processing of the tentative allowance.

    1. Taxpayer’s RAR prepared per the instructions in this section, and

    2. A RAR with the following notated in the top margin "For Case Processing Use ONLY" — Prepare this RAR using RGS (this will ensure that Form 5344is correct). The taxable income should reflect the taxable income as previously adjusted by incorporating the tentative carryback per the transcript.

  4. TAX PREVIOUSLY ADJUSTED — The tax as previously adjusted should include any tax decrease allowed in processing of the tentative allowance. The report should include a schedule showing the computation of the tax as previously adjusted.

  5. EXAMPLES OF A REPORT AFTER A TENTATIVE ALLOWANCE — Facts: Corporation X files its 1992 Form 1120timely. The taxable income is $888,888 and the tax is $302,222. In 1995 there is a net operating loss of $30,000. On 4/30/96, a Form 1139is filed and the corporation receives a refund of $10,200. The 1992 and 1995 returns are examined.

    1. Example 1: The examination results in no change to 1995. Therefore the NOLD is allowed in full in 1992. There is no change in tax because the corporation has already received the tentative refund. See Exhibit 4.10.8–10.

    2. Example 2: The examination results in additional income in 1995 of $17,000. This reduces the NOLD to $13,000. There is a deficiency in 1992 of $5,780 because the corporation received a tentative refund based on a NOLD of $30,000. See Exhibit 4.10.8–11.

    3. Example 3: The examination results in income in 1995 of $50,000. This eliminates the NOLD. There is a deficiency of $10,200 because the corporation received the tentative refund of $10,200. Exhibit 4.10.8-12.  (08-11-2006)
Restricted Interest

  1. Interest is charged on a tax deficiency under IRC section 6601 for the period of time the taxpayer had use of the government’s money, or is paid on an overassessment or overpayment under IRC section 6611 for the time the government has the taxpayer’s money. In most instances, the period of time for which interest is charged or paid to the taxpayer begins on the due date of the return.

    1. Examination changes that follow this rule are called "General Adjustments" .

    2. Examples include adjustments to expenses, changes to income, increases or decreases in a current credit, and adjustments made to losses/credit carried forward from prior years.

  2. The interest accrual period is shorter, or "restricted " if certain deductions, credits, or items of income are present.

    1. Examination changes to these items are called "Restricted Adjustments" .

    2. Examples include net operating loss, capital loss, or credit carrybacks from a subsequent year. In these cases, the interest is computed from the due date of the source year of the carryback item. This is also called the effective date of the restricted adjustment.

    3. See IRM Exhibit 20.2.8-1 which lists the deductions, credits, or items of income and the provisions of the Code which "restrict" interest.

  3. Cases with restricted interest adjustments are complex and require special handling.

    1. Unagreed cases are sent to Appeals via Technical Services.

    2. Agreed cases with certain refunds over $2 million are sent to Joint Committee Review in LMSB. For more details on Joint Committee criteria, see IRM 4.36.

    3. Agreed cases that do not meet Joint Committee criteria are sent to Technical Services if they require a Form 2285 to be prepared.

    4. After section I of Form 2285is completed for an LMSB Coordinated Industry Case, the SBSE Technical Services or LMSB Joint Committee reviewer should send a copy of the form to the team coordinator for its inclusion in the case historical file. If reviewers or Case Processing personnel have any questions about the computations for any Form 2285,they should contact the examiner who prepared the report for clarification before sending it back to the group.

    5. Form 2285is required when one or more of the following three criteria are present:
      • Both general adjustments and restricted adjustments,
      • Carryback adjustments from more than one tax period, or
      • More than one restricted interest computation date.

    6. In these cases requiring Form 2285,the examiner’s report should clearly reflect adjustments to carrybacks or recapture of NOLs or credits. The adjustment on the RAR should reflect the source year of the carryback, i.e., "NOL carryback from tax year YYYYMM" . Case Processing will use the completed Form 2285to compute the interest for the tax year(s) on the RAR.


      For more instructions related to suspended interest See IRM

    7. In complex cases with multiple restricted adjustments, it is suggested that the examiner prepare a joint committee spreadsheet for the applicable period(s). See IRM

    8. Agreed cases that do not meet Joint Committee jurisdictional amount and do not require a Form 2285 should be sent to Case Processing in status code 51.

    9. To aid Case Processing in computing the restricted interest adjustment, examiners should reflect the source year of the carryback in the adjustments section of the RAR and identify the tax periods containing the restricted adjustments on Form 3198.

  4. In applying these rules, examiners should disregard any restricted adjustment that represents a tentative allowance filed on Form 1045or Form 1139that has been accepted as filed. This is because when the tax is paid, the campus function automatically generates a restricted interest computation.

  5. For all cases with restricted interest:

    1. Form 4549or other appropriate form with all adjustments identified should state in "Other Information " the following or similar statement, "This report involves restricted interest. In such cases, some or all of the interest is computed from a date other than the due date of the return" .

    2. Additional language should be added to explain the computation period. Examples include:
      "Interest allocated to your NOL carryback from 2004, is computed from the due date of that return, 3/15/2005" .
      "Under IRC section 6404(g),interest is suspended from MM/DD/YYYY to MM/DD/YYYY" .
      "Your tentative refund filed on Form (1045 or 1139) for YYYYMM has been (fully or partially) disallowed. The interest related to this adjustment is restricted to the due date of the source year return" .

    3. Notate on Form 3198as a " Restricted Interest – Form 2285Required " or "Restricted Interest – No Form 2285" so the case is properly assigned when it arrives at Technical Services or Case Processing.

  6. For restricted interest cases that result in no change to tax liability, a statement should be added to the "Other Information" section of the report: "Even though there is no change in your tax liability, there may be interest payable or receivable as a result of this report. This is because one or more of the adjustments is a restricted adjustment. Tax related to this adjustment has an interest computation date different from the return" . See IRM The examiner should solicit the taxpayer’s agreement in such cases.

  7. For a step-by-step decision model for handling restricted interest cases, see the Restricted Interest Decision Chart at Exhibit 4.10.8-13.  (06-10-2005)
Filing Status: Joint Return Converted to Separate Returns

  1. Treas. Reg. § 1.6013–1(a)(1), Joint Returns, does not allow a husband and wife to change from a joint return to a separate return, unless prior to the due date of the return (without regard to any extension of time to file) either spouse subsequently files a separate return. The separate return is a superseding return.

  2. SEPARATE RETURN FILED BY AN EXECUTOR — Under certain circumstances, a surviving spouse may file a joint return for the year of death if an executor or administrator has not been appointed by certain times. IRC § 6013(a)(3), and Treas. Reg. § 1.6013–1(d)(3) & (4). An executor or administrator for a deceased person may disaffirm a joint return filed by the surviving spouse. See IRC section 6013(f)(4) and Treas. Reg. § 1.6013–1(d)(5).

  3. INVALID "JOINT ELECTIONS" — Sometimes, after a joint return is processed, it is determined that the joint election is not valid even though the return, itself, is valid for purposes of IRC section 6011 and IRC section 6012. Some reasons a joint election may not be valid include:

    • The taxpayers were not married,

    • The return is not signed by both parties,

    • The return was signed under duress (Treas. Reg. § 1.6013–4(d)),

    • One spouse’s signature was forged.


    A return that is not signed may be corrected by obtaining a valid signature using Letter 2348. Also, the return may be treated as signed by establishing both spouses intend to file a joint return. See Federbush v. Commissioner, 34 T.C. 740, 757 (1960), aff’d per curiam, 325 F.2d 1 (2d Cir. 1963).  (08-11-2006)
Closing the Return of the Primary Taxpayer if the Joint Election is Invalid

  1. When closing the return of the person whose Social Security number is listed first (the primary taxpayer) on the "joint return," the following actions should be taken:

    1. Prepare a report using the correct filing status and only the income, deductions and credits of the primary taxpayer.

    2. Solicit agreement from the taxpayer.

    3. Follow normal agreed/unagreed procedures.

    4. Show only one name on Form 5344.

    5. Check the "Change Filing Status to: _____" block in the "Special Features" category of Form 3198.

    6. Check the "Name or Address has been changed from Return " block in the "Change of Address." category of Form 3198and enter one of the following comments in the Special Features section of Form 3198, in Other Instructions section:
      (1) If Form 2363,Master File Entity Change, was previously submitted, note "Form 2363, was submitted on (date) to remove (name) from this account;"
      (2) If Form 2363was not previously submitted, note "Remove (name of appropriate spouse) from this account."  (06-10-2005)
Closing the Return of the Person Whose Name was Removed from the Joint Return

  1. If the file does not already contain the separate return for the person removed from the joint return, the return should be solicited (if a return is required). That return should be closed together with the " joint return" with instructions to the Case Processing function to process the return as an original return.

  2. If a return is required and is not filed, follow substitute for return procedures to make an assessment against the person whose name was removed from the "joint return."  (06-10-2005)
Filing Status: Separate Returns Converted to Amended Joint Return

  1. A husband and wife who originally filed returns on a separate basis may find it to their advantage to use a joint tax computation. To change from separate to joint return status taxpayers may (a) file a joint return an amended Form 1040 or Form 1040X.

  2. For tax years beginning on or after July 31, 1996, (e.g., calendar year 1997), it is not necessary for taxpayers to pay the tax shown on the joint return in full as a condition to electing joint status.  (08-11-2006)
Procedures for Delinquent and Substitute for Returns for Joint Return Filing Status

  1. Internal Revenue Code section 6020(a) authorizes the Secretary to prepare a return for a taxpayer who fails to make and file a return if the taxpayer discloses all information necessary for the preparation of the return. If the taxpayer signs the return prepared by the Secretary, the return may be received as the taxpayer’s return.

    1. If a taxpayer fails to make a return, or makes a false or fraudulent return, IRC section 6020(b) authorizes the Secretary to make a return from his own knowledge and from such information as he can obtain through testimony or otherwise.

    2. Internal Revenue Code section 6065 requires that a return " shall contain or be verified by a written declaration that it is made under the penalties of perjury."

    3. Joint return filing status under IRC section 6013(a) is predicated on the husband and wife making an election and intending to file a joint return. Accordingly, the Service may not elect joint filing status on behalf of taxpayers in a return it prepares and signs under the authority of IRC section 6020(b). See Millsap v. Commissioner, 91 T.C. 926 (1988), acq. in result, 1991–2 C.B. 1 (filing status used by IRS in preparing return under IRC section 6020(b) does not bind taxpayers in later deficiency proceeding).

    4. A Form 870 signed by taxpayers, husband and wife, is not a return under IRC section 6020(a) and it is not an election to file a joint return under IRC section 6013. This holding also applies to Form 1902, Report of Individual Income Tax Audit Changes (obsoleted 1988), and Form 4549, Income Tax Examination Changes, and any successor forms to these forms, because these documents do not purport to be returns and do not contain a "jurat" with a penalties of perjury clause.

    5. If married taxpayers fail to execute a joint return, the examiner will have to close the case unagreed using a filing status other than married filing joint. Generally, these taxpayers’ filing status will be married filing separate. Based on facts and circumstances, the examiner will need to determine if a return is needed for one or both taxpayers. See Revenue Ruling 2005-59.  (06-10-2005)
Statute Considerations

  1. IRC section 6013(b)(2)(A) requires that taxpayers make this election within three years of the original due date of the tax return (without regard to an extension).

  2. IRC § 6013(b)(2)(B) requires that taxpayers make this election prior to the mailing of a notice of deficiency for that year to either spouse if the spouse files a timely petition with the Tax Court with respect to that year.

  3. IRC § 6013(b)(2)(C) requires that taxpayers make this election prior to commencing suit in any court for recovery of any part of the tax for such taxable year.

  4. IRC § 6013(b)(2)(D) requires that taxpayers make this election before either spouse has entered into a closing agreement with respect to such taxable year, or before any civil or criminal case arising against either spouse with respect to such taxable year has been compromised.  (06-10-2005)
Examination of Return

  1. If an amended return is received during an examination, examiners generally will examine the amended return to determine whether the tax reported is correct. The examination will be made as soon as possible after the return is received and to the extent deemed necessary. An amended return received from a taxpayer during an examination, with or without remittance, will remain with the case file.

  2. Separate files should be set up for each spouse as each file will be closed under its own Document Locator Number (DLN) . Generally, the primary file will be the first SSN shown on the joint return and the secondary file will be the second SSN shown on the joint return.

    1. The primary file will include the original or copy of the joint amended return. The primary’s original separate return and a copy of the secondary’s separate return should be attached.

    2. The secondary file will include the secondary’s original separate return. A copy of the first page of the joint amended return should be attached.  (06-10-2005)
Preparation of Reports

  1. Two reports will be prepared when separate returns are converted to a joint return.

  2. PRIMARY FILE — prepare a report starting with the primary account and include as adjustments the items appearing on the secondary separate return. At the conclusion of the examination, the examiner will solicit an agreement covering the proposed changes. If a deficiency is unagreed, normal appeal procedures apply.

  3. SECONDARY FILE — prepare a second report to adjust all tax and penalties previously assessed on the secondary account to zero.  (06-10-2005)
Closing Procedures

  1. The primary and secondary files should be closed to Case Processing together as one case file.

  2. Prepare a Form 5344for each file and include the name of the secondary taxpayer on the Form 5344for the primary file.

  3. Prepare Form 3198,to be transmitted with the case file, and include the following comments:

    1. "Separate Return(s) Converted to Joint, "

    2. "Add secondary taxpayer to primary account,"

    3. Indicate any estimated tax payments to be transferred from the secondary account to the primary account, and

    4. Indicate whether or not the tax has been paid.  (06-10-2005)
Adjustments to the Investment Credit

  1. A report including adjustments to investment credits (including the recapture of investment credit) should include a computation showing the correct investment credit.

  2. IRC section 46 defines the credits which are considered investment credits. Form 3468may be used to show the computation of the corrected investment credit.

  3. IRC section 38 limits the amount of general business credits (including investment credit) which may be used in any year. Form 3800,General Business Credit, may be used to show the limitations of the investment credit when the taxpayer is eligible for more than one type of General Business Credit. The report should clearly show the amount and year of origin of any adjustments to investment credit carrybacks or carryforwards.

  4. IRC section 50(c) requires the recapture of all or part of the investment credit in the case of an early disposition of the property which generated the credit. Form 4255, Recapture of Investment Credit, may be used to show the computation of the tax due to the recapture of the investment credit.  (06-10-2005)
Self-Employment Tax Adjustments

  1. When an audit results in an adjustment to self-employment tax, the information is forwarded electronically to the Social Security Administration via the Form 5344,Examination Closing Record. See IRM (AIMS/Processing Handbook, Social Security Administration (SSA) Adjustments; Returns Processed After 1/1/86).

  2. Include the following information as applicable on the Form 5344: (See IRM; Reference Code Changes to Self-Employment/Income Tax):

    1. REFERENCE NUMBER 878: a net increase or decrease to the self-employment income of the primary taxpayer

    2. REFERENCE NUMBER 879: a net increase or decrease to the self-employment income of the secondary taxpayer.

    3. For 1990 and subsequent tax years, enter the self-employment income adjustments multiplied by 9235. The net increase or decrease to the self-employment tax reference number is 889. Changes to both primary and secondary self-employment tax should be combined for one adjustment to reference number 889.


    Separate adjustments must be made for the social security portion and Medicare portion of the self-employment tax. The maximum amount of combined wages and self-employment earnings subject to social security tax was $87,900 for 2004. There is no limit on wages and self-employment earnings subject to Medicare tax.  (08-11-2006)
Adjustment to FICA Tax on Tip Income Not Reported to Employer

  1. If it is discovered during an examination that tip income has been underreported by the employee to the employer, FICA tax may have to be adjusted. See IRM, AIMS/Processing Handbook - Social Security Administration (SSA) Adjustments: Tip Income, and IRM, Report Writing Guide for Employment Tax Examinations: Procedures for Employee Tax Adjustment on Tip Income Not Reported to Employer.  (08-11-2006)
Adjustment For Employee FICA Tax

  1. The following procedures should be followed when an examination results in an adjustment to employees share of FICA tax where the employer is not liable due to Section 530 of the Revenue Act of 1978, 95 PL 600.

  2. Form 885–Ewill be prepared. See IRM, Report Writing Guide for Employment Tax Examinations: Procedures for Adjusting the Employee’s Share of FICA.

  3. The examiner’s report will contain the computation and explanation of the adjustment. The following statement can be used:
    " Your correct liability for FICA is $ X,XXX.XX. ($___ of wages x __%). In connection with the examination of your income tax return, Form 1040, for the year(s) ____, an adjustment has been made for the employee share of the FICA tax imposed by Section 31.3102–1(c) of the Employment Tax Regulations in the amount of $ ____. "

  4. The adjustment for the employee share of FICA will be reflected on Form 2504since the adjustment for employee FICA tax is not an income tax adjustment.

  5. To ensure proper processing, Form 3198must be prepared and attached to the case file. In the "other" section, include the statement, "Form 885–E enclosed."

  6. If an adjustment for SECA tax is also involved, include in the "other" section of Form 3198the statement, "Form 885–E enclosed."

  7. Preparation of Form 885–E,Part A: Enter the amounts received during the respective periods indicated. If unable to accurately determine amounts per period, the amount of reclassified wages should be deemed to be earned equally over the periods the worker performed the services. The remaining parts are self-explanatory.  (06-10-2005)
Adjustment to Schedule H — Household Employment Taxes

  1. Beginning in 1995, an individual who employs domestic workers is able to report employment tax payments annually on Schedule H, " Household Employment Taxes" (which is attached to form 1040, 1040-NR, 1040-SS) instead of filing quarterly 942 Forms. If an individual is not required to file an income tax return (for example, because income is below the amount that requires the individual to file) Schedule H may be filed by itself.

  2. The use of Schedule H to report and collect these taxes does not change the nature of the tax.

    1. Changes are employment tax changes.

    2. Changes cannot be included in the income tax report.

    3. Changes must be made on Form 4668,"Employment Tax Examination Changes Report. "

    4. Changes are not subject to statutory procedures and should not be included on a Statutory Notice of Deficiency.

    5. No portion of the employment tax reported on Schedule H is ever available for refund based on changes to a taxpayer’s income tax liability.

  3. For purposes of Schedule H the employer is:

    1. The taxpayer who applied for the EIN, which is required.

    2. For joint returns, only one taxpayer can be the employer and this would be the spouse who obtained the EIN.

  4. Adjustments to Schedule H require the preparation of Forms 4667, 4668, and 2504. The adjustment should be made to the fourth quarter of these forms, where applicable.

  5. When Schedule H adjustments are made, Form 3198 must be attached to the case file.

    1. The Other Instruction section should contain the following notation:
      "Schedule H Adjustment — Forms 4667, 4668 and 2504 enclosed for the primary or secondary (whichever applies) taxpayer."

    2. For joint filers, it is critical that the primary/secondary designation be made to allow for accurate completion of Form 5344.

  6. As with any other employment tax changes involving wages, corrected or delinquent W–2’s should be secured as necessary.  (08-11-2006)
Specialists Report

  1. ENGINEER’S MEMORANDUM REPORT, FORM 3213,— is used as the report transmittal for the engineer's report on non-LMSB cases. The Issue Management System (IMS) is used to transmit reports on LMSB cases.

    1. For more detail regarding the content of the engineer's report see IRM 4.48.1,Engineering Program.

    2. Form 4665will note that an engineer was involved in the case and whether or not the engineer's findings are accepted. When accepted, the engineer’s findings will be included in the examiner’s report. Workpapers related to the engineering report on SB/SE cases should be placed in Section 600 of the case file.

  2. INTERNATIONAL EXAMINER’S REPORT, FORM 3963, — is used as the report transmittal for the international examiner's report on SB/SE and LMSB cases. Form 3963provides administrative information, compliance check information, issues considered but not changed, and Form 886–A,Explanation of Items, etc.

    1. For more detail regarding the preparation of Form 3963see IRM 4.60.9,International Examiner's Report.

    2. Form 4665will be noted International was involved in the case and whether or not the international examiner's findings are accepted. When accepted, the international examiner’s explanation of items will be included in the examiner’s report. Workpapers related to the International Examiner's report should be placed in Section 600 of the case file.  (08-11-2006)
Notice Under IRC Section 6404(g) – Suspension of Interest

  1. Interest that a taxpayer is charged on a deficiency is suspended if the Service fails to provide timely and adequate notice of a tax liability. IRC section 6404(g) applies to timely filed individual (1040) income tax returns for taxable years ending after July 22, 1998. For taxable years ending after July 22, 1998, the Service must provide notice of the liability before the close of the 18-month period that begins on the later of the original statutory due date of the return or the date the return was filed, if filed timely under a valid extension. Interest resumes on the 21st day after the notice stating the liability and the basis for the liability is provided to the taxpayer.

  2. A notice provided within the prescribed time period would prevent the suspension of interest if the notice adequately states the amount of the liability and the basis for the liability. A notice should be written and contain enough information regarding the adjustment to enable the taxpayer to challenge the adjustment. The examination report, Form 4549, Income Tax Examination Changes, is sufficient notice if it contains an explanation of each item of adjustment.

  3. Rev. Rul. 2005-4, Interest Suspension; Time Sensitive Penalties, extends the scope of IRC section 6404(g)interest suspension rules to include additional liability voluntarily reported by taxpayers on amended returns to the IRS. In this situation, examiners should refer to IRM see Rev. Rul. 2005–4.

  4. The explanation of each item of adjustment will be added to the examination report by attaching one or a combination of the following which will list each adjustment and an explanation of each adjustment:

    1. The standard paragraphs accessible in RGS

    2. Copies of lead sheets

    3. A written explanation for the adjustment

  5. The IRC section 6404(g) notice date must be noted on a copy of the notice retained in the case file. This information should be recorded in the "Other Information" section of the examination report (Form 4549) using language similar to:
    "IRC section 6404(g) does apply, and notice was provided on (date)."

    If there is more than one IRC section 6404(g) notice date, as defined by IRM,each notice date and the portion of the liability attributable to each notice date will be recorded in the "Other Information" section of the examination report and should contain the following language:
    "IRC section 6404(g) applies and there are XX different notice dates. The first notice was provided on (date) for $(amount of liability); the second notice was provided on, etc.."

  6. As a result of IRC section 6404(g), notice dates and amounts of liabilities must be entered on Master File with a Transaction Code (TC) 971 and Action Code 64. Case Processing is responsible for inputting TC 971 with the notice date and amount.

  7. On every individual case with a liability adjustment, examiners must indicate on Form 3198,Special Handling Notice, IRC section 6404(g) is not applicable or enter the notice date(s) and the applicable liability amount.

  8. If there is more than one IRC section 6404(g) notice date, note on Form 3198that restricted interest applies due to IRC section 6404(g), and to see the "Other Information" section of the examination report.

  9. See IRM 20.2.7,Abatement and Suspension of Interest: IRC §§ 6404 and 7508.  (06-10-2005)
Individual Retirement Account (IRA) and Qualified Retirement Plan Adjustments

  1. There are generally two types of changes that may be made as a result of transactions involving an Individual Retirement Account (IRA) or qualified retirement plan during an examination:

    a. Adjustments to Income: b. Taxes Resulting from not Complying with IRA Rules:
    1. Adjustments to income, such as the taxpayer’s deduction for an IRA contribution or inclusion of premature distributions in income, will be reflected on the "adjustments to income" line on Form 4549, Income Tax Examination Changes. 1. Taxes, such as IRC § 72(t), tax on early distributions and IRC §§ 4973, 4974, and 4980A, taxes for excess contributions, accumulations, and distributions, are reflected on the "Plus Other Taxes" line of Form 4549 as an addition to the corrected tax liability.
      2. The type of tax will be identified in the "Other Information " section.
      3. A lead sheet must be attached to show the computation of the tax. In joint return cases, the spouse to whom the tax pertains must be identified on the lead sheets. If it applies to both spouses, the amount of tax applicable to each spouse will be identified.
      4. These taxes are normally reported on Form 5329.

  2. IRM, IRA Taxes, lists the taxes that may be assessed on IRAs and qualified retirement plans if the taxpayer does not conform to rules governing IRAs. Attention should be given as to whether the tax is an income or excise tax as this will affect the preparation of the reports and the statute of limitations.


    If a consent to extend the statute of limitations is being prepared and an excise tax due to an IRA may be assessed, complete the "kind of tax" line on the consent form, by inserting "Income and Chapter 43 (Excise) Tax. " The excise tax statute must also be extended in addition to the income tax statute if there is a possibility that an excise tax may be assessed.  (06-10-2005)
Posting Advance Payments

  1. Separate Form 3244-A,Payment Posting Voucher, must be prepared for each type of tax, taxpayer, and tax period. Therefore, separate Forms 3244-A must be completed if an advance payment is received on a deficiency that:

    1. includes both income and excise tax, or

    2. is attributable to both spouses on a joint return for an IRA/qualified retirement plan adjustment.

  2. The MFT block will be noted "MFT 29" and the "Remarks" block noted "IRA-MFT 29" if the tax is an excise tax.

  3. One check may be accepted for payments that relate to both income and excise tax.  (06-10-2005)
Form 5344 – Examination Closing Record

  1. Separate Form 5344, Examination Closing Record, are required for processing:

    1. each individual’s IRA/qualified retirement plan adjustments, and

    2. the income tax adjustments.
      Therefore, if a joint return is under examination and both spouses' IRAs/qualified retirement plans are adjusted in addition to other income tax adjustments, three Form 5344s will be required - one for the income tax adjustments and one for each spouse’s IRA adjustments.

  2. Entries on Form 5344for IRA/qualified retirement plan adjustments are generally the same as those for income tax adjustments, except no entries are required in items 18 through 40. Refer to IRM 4.4.14, Individual Retirement Accounts (IRA) Adjustments, for instructions in completing the entries on Form 5344.  (06-10-2005)
Form 3198 – Special Handling Notice

  1. Case files containing IRA/qualified retirement plan adjustments will be identified on Form 3198,Special Handling Notice, by checking the Special Features "Other Instructions " block, followed by "IRA adjustment" , the type of tax (i.e., 6%, 50%, etc.), the amount of tax attributable to each type of tax and identifying the SSN of the account to be adjusted.  (08-11-2006)
Examination Information Reports — Form 5346

  1. When, during an examination, an examiner develops an issue or receives information of sufficient compliance value to warrant enforcement action, Form 5346 will be prepared.

  2. For entities and years directly related to an ongoing examination, Form 5346, Examination Information Report, should be prepared when one of the following exist:

    1. The taxpayer has not yet filed the return in question. If the taxpayer has filed the return, the scope of the examination should be expanded to include the additional return.

    2. The return in question was (or will be) filed in another area.

    3. The information received does not effect the taxpayer under examination or a return related to the taxpayer.

  3. Information discovered not related to an ongoing examination (i.e. newspaper articles etc.) must always be submitted on Form 5346 to the PSP for evaluation and follow-up. Examiners and group managers are not authorized to initiate examinations based on this type of information, even if the taxpayer is located in their POD/area.

  4. The instructions for preparing Form 5346 are included on the reverse of the form. Examiners should include sufficient information to allow evaluation of the audit potential. If necessary, documentation may be attached to the form.


    When a claim is involved, the examiner must line through the preprinted source 60 and enter source code 30 and a claim amount.

  5. Form 3198, attached to the case file, should include the statement, "Form 5346 enclosed." Case Processing will forward the form to PSP for evaluation and follow-up.

  6. After the examiner prepares a Form 5346, he should secure his manager's approval.

  7. Examiners should document any action taken regarding Information Reports on Form 9984,Examining Officer’s Activity Record, and Form 4318,Examination Workpapers.

  8. References for Examination Information Reports:

    • IRC section 7213A- Unauthorized Inspection of Returns or Return Information

    • IRM Examination Information Reports - Form 5346

    • IRM Form 5346

    • IRM Returns Not Filed

    • IRM Examination Information Reports

    • IRM Delinquent Information Returns

    • IRM Information Reports  (08-11-2006)
When Not to Submit Form 5346

  1. There is a non-material tax effect.

  2. There is less than 180 days remaining on the normal statute. If less, there must be a firm and clearly defined issue involving substantial additional tax before a Form 5346is prepared or approved.  (08-11-2006)
Report Transmittal: Form 4665

  1. Report Transmittals are used as a cover document for confidential information or as a summary of the attached documents. The use of this document is optional for office examination.

  2. Circumstances requiring use of Form 4665 include, but are not limited to:

    1. Partially agreed and unagreed cases (optional for office audit)

    2. Joint investigation cases (see IRM

    3. Criminal investigation cases

    4. Criminal prosecution cases

    5. Presentation of inconsistent "whipsaw " issues (see IRM

    6. Transmittal of engineer’s or international examiner’s report

    7. 25% Omission ( IRC section 6501(e)) cases - include a computation

  3. Form 4665and attachments are not normally furnished to the taxpayer. Not withstanding, examiners should avoid comments based on hearsay, rumor or gossip; comments of a derogatory nature; or identification of an informant (or other source of confidential information) by name, occupation, or relationship.  (05-14-1999)
Inadequate Records Notices: Overview

  1. Every taxpayer is required by law and regulations to maintain records with sufficient detail to prepare a proper return. This may require the maintenance of such permanent books of account and records sufficient to establish the amounts of gross income, deductions, credit, or other matters to be shown on the taxpayer’s return. See Treas. Reg. § 1.6001–1.

  2. Taxpayers who maintain automated records can enter into a record retention agreement with the Area Director. This agreement limits retained records to those specifically identified as needed to perform auditing procedures.

  3. Inadequate Records Notices place taxpayers on notice that their recordkeeping practices are deficient and must be improved to meet the requirements of the law. The issuance of an Inadequate Records Notice may result in a follow-up examination and is a tool to enforce taxpayer compliance with legal requirements to keep adequate records and properly report tax liabilities.  (05-14-1999)
Determination of Taxpayer Compliance

  1. The determination that a taxpayer has not maintained adequate books and records, or has not complied with a record retention agreement, is a matter of judgment and should be based on the facts of the individual case. Factors to be considered include, but are not limited to:

    1. An alternative or indirect method was used to establish the amounts of gross income, deductions, credits, or other matters shown on the taxpayer’s return because the taxpayer’s records were not sufficient,

    2. Prior history and present degree of noncompliance,

    3. Indications of willful intent or evidence of refusal to keep adequate books and records,

    4. Probability that the inadequacies in recordkeeping will result in significant underreporting of tax liabilities, or

    5. Other evidence of harm to the Government.

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