4.10.9  Workpaper System and Case File Assembly

Manual Transmittal

August 11, 2014

Purpose

(1) This transmits a revision of IRM 4.10.9, Examination of Returns, Workpaper System and Case File Assembly.

Material Changes

(1) Minor editorial changes have been made throughout this IRM. Also, website addresses, legal references, and IRM references were reviewed and updated as necessary. Other significant changes to this IRM include the following:

Prior IRM Reference New IRM Reference Description of Change
N/A N/A The title of IRM 4.10.9 has been changed from "Workpapers" to "Workpaper System and Case File Assembly" in order to more clearly reflect the content.
N/A Throughout IRM Deleted references to Form 4700 and replaced with Form 4318-OA.
IRM 4.10.9.1 IRM 4.10.9.1 Updated and clarified guidance to include lead sheets and case file organization.
N/A IRM 4.10.9.3 Moved RGS content from IRM 4.10.9.4.5 to a separate subsection.
N/A IRM 4.10.9.2 Added new subsection to address ex parte communications when documenting case files.
IRM 4.10.9.2 IRM 4.10.9.4 Renamed and revised to provide an overview of the workpaper system. Moved all content related to lead sheets to IRM 4.10.9.6. Moved all content related to workpapers to IRM 4.10.9.7.
IRM 4.10.9.3 IRM 4.10.9.5 Moved all content related to the activity record before discussion of administrative and issue lead sheets to improve flow and updated guidance.
IRM 4.10.9.3.1 IRM 4.10.9.8 Moved, renumbered, and updated guidance.
N/A IRM 4.10.9.6 Moved all content related to administrative and issue lead sheets to new subsection. Updated and clarified guidance.
IRM 4.10.9.4 IRM 4.10.9.7 Moved all content related to workpapers into one subsection. Updated and clarified guidance.
IRM 4.10.9.5 IRM 4.10.9.9 Moved, renumbered and updated guidance.
IRM 4.10.9.5.2 (1)h IRM 4.10.9.9.2(1)g Revised procedures to instruct examiners to close case using Tax Module All (TXMODA) instead of IMFOLT/BMFOLT.
N/A IRM 4.10.9.10 Added new subsection to address mailing cases.
Exhibit 4.10.9-1 N/A Deleted because the information in this exhibit is no longer referenced in this IRM and it is now included in IRM 4.10.15

Effect on Other Documents

IRM 4.10.9, dated February 1, 2010, is superseded.

Audience

SBSE Field Examination Employees

Effective Date

(08-11-2014)

Shelley M. Foster
Acting Director, Examination Policy
Small Business/Self-Employed

4.10.9.1  (08-11-2014)
Overview

  1. This section provides guidelines for the development of lead sheet and workpaper content and for workpaper and case file organization. These guidelines are provided to promote quality and consistency in the preparation and completion of lead sheets, workpapers, and case files.

  2. Leads sheets and workpapers are the written records that support the audit findings. Lead sheets and workpapers must document the audit activities including audit steps and techniques applied, tests performed, information obtained, and conclusions reached. They must include all the information necessary to support the audit results.

  3. Lead sheets and workpapers serve four basic purposes:

    1. Provide a framework to plan the audit, including the analysis of internal documents, and set the scope of the exam.

    2. Document the evidence gathered, audit steps and techniques applied, tests performed, and analyses conducted during the audit process.

    3. Support the factual and technical conclusions.

    4. Provide a basis for review by management and other stakeholders (e.g., Treasury Inspector General for Tax Administration (TIGTA) reviewers and Counsel). Well prepared workpapers facilitate review by numerous customers.

  4. Lead sheets and supporting workpapers constitute official government documents. They must be professional and objective in tone and language as well as free of unwarranted personal opinion and bias.

  5. Examiners must contemporaneously update the lead sheets and supporting workpapers during the audit. As issues are resolved, lead sheets and workpapers should be finalized, printed and included in the case file.

4.10.9.2  (08-11-2014)
Ex Parte Communications

  1. Case files are not considered to be ex parte communications within the context of Rev. Proc. 2012-18 , 2012-10 IRB. 455. It is permissible to contemporaneously include statements or documents that are pertinent to the examiner's consideration of the case. However, examiners must refrain from placing notes, memoranda, or other documents that normally would not be included in the case file in the ordinary course of developing the case if the reason for including this material is to attempt to influence Appeals’ decision-making process.

    Note:

    The case file must not include "gratuitous" comments in the case history, a memorandum to the file, or a transmittal document (e.g. Form 4665), if the substance of the comments would be prohibited if they were communicated to Appeals separate and apart from the case file.

  2. See IRM 4.2.7, Ex Parte Communication Procedures, and the Ex Parte Communications page of the MySBSE website, for additional information and guidance.

4.10.9.3  (08-11-2014)
Report Generation Software (RGS)

  1. RGS is the software program utilized in the examination process to:

    • Compute corrected tax, interest, penalties, and generate audit reports

    • Create various forms and letters

    • Document the examiner's actions and findings

    • Process and archive audit results

  2. RGS is required for all income tax audits of Form 1040 (except a Form 1040 with a fiscal year), Form 1120, Form 1120S, and Form 1065 returns. See IRM 4.10.15.1.2 for additional information.

    Note:

    Tax computation aids are available for Form 1041 on the Trusts (Domestic) website.

4.10.9.4  (08-11-2014)
Workpaper System

  1. The workpaper system includes:

    1. Form 4318, Examination Workpapers Index, or Form 4318-OA, Examination Workpapers Index - Office Audit,

    2. Form 9984, Examining Officer's Activity Record,

    3. Administrative and issue lead sheets, and

    4. Supporting workpapers.

  2. Form 4318 or Form 4318-OA is the cover sheet that indexes the administrative and issue lead sheets, as well as supporting documents (e.g. information document requests, correspondence, case building materials). It pertains to one taxpayer (or both spouses for jointly filed returns) and includes all tax years under audit. If there are more than three years under audit, examiners must also use Form 4318-A, Continuation Sheet for Form 4318, Examination Workpapers Index.

  3. The workpaper system is designed to facilitate consistent organization of case files and eliminate duplication.

  4. Lead sheets and supporting workpapers:

    • Reflect the evidence gathered, explanations, analyses and conclusions reached.

    • Effectively explain the issues addressed during the audit.

    • Provide the evidence to reflect the scope and depth of the audit.

    • Support the determination of the tax liability.

    • Reflect the audit trail, allowing a subsequent reviewer to trace a transaction or event and related information from beginning to end.

4.10.9.5  (08-11-2014)
Activity Record

  1. Form 9984, indexed as Lead Sheet 100, should be used to document each action taken on the case. The activity record should be prepared contemporaneously and provide a complete and concise case history. Form 9984 chronicles all actions on the part of the examiner, group manager, clerical support staff, taxpayer and/or the taxpayer's representative, etc. during the course of the audit.

  2. Form 9984 is a brief summary of actions taken and in some cases will reference other workpapers for more detail. All entries on Form 9984 should be written factually and professionally, omitting personal opinions.

  3. Examiners using the RGS program may use the RGS Case History application in place of Form 9984, however, they must use caution when using this application because the case history entries can be lost. Examiners must back up to the file server each time a new RGS Case History Report is saved. See IRM 4.10.15.2.3, Case History (Optional), for additional information.

  4. Information recorded on Form 9984 should include the date, location, time charged, and an explanation of each activity or contact, including but not limited to:

    1. Work performed prior to, during, and subsequent to taxpayer contact;

    2. Research activities;

    3. Pre-plan actions taken to determine the depth and scope of the audit;

    4. Date the tour of the business site or inspection of the taxpayer’s personal residence was conducted;

    5. Brief summaries of telephone conversations;

    6. Contacts with taxpayers, representatives, and third parties;

    7. Causes for any delays by the Service (training, details, etc.);

    8. Causes for any delays by the taxpayer, and/or representative;

    9. Group manager involvement (including informal discussions, formal discussions, in-process case reviews, on-the-job-visitations, and workload reviews, etc.);

    10. Collateral requests and referrals;

    11. Actions with respect to the statute of limitations; and

    12. The dates the case was (1) closed to the group manager, (2) closed by the group manager, and (3) closed by the clerical staff.

4.10.9.6  (08-11-2014)
Lead Sheets

  1. Examiners must use the administrative and issue lead sheets in the RGS program. See IRM 4.10.15.1.2, RGS Inventory/Case Management, for additional information.

  2. Administrative and issue lead sheets serve as an index and summary for supporting workpapers and provide the following benefits:

    • Consistent format, making the case file easier to review

    • Streamline the audit process

    • Include audit steps that assist the examiner through issues with which they are unfamiliar

    • Allow audit steps to be added, modified or eliminated

  3. See IRM 4.10.15.2.14, Lead Sheets, and IRM 4.10.15.1.4, Documents Included in RGS, for additional information about lead sheets.

4.10.9.6.1  (08-11-2014)
Administrative Lead Sheets

  1. Administrative lead sheets address the administrative items requiring comment by the examiner (e.g., initial interview, required filing checks and minimum income probes). They are also used as guides to assist the examiner with properly completing the audit.

    Caution:

    If a lead sheet contains check boxes, they should be used to notate the applicability of an action taken. Supporting documentation to explain the action taken should be included. Generally, check boxes by themselves are not adequate supporting documentation. IRM 4.10.2.6 (7), Pre-Contact Planning or Examination Activities, provides additional guidance regarding the use of check boxes.

  2. In general, administrative lead sheets do not contain an adjustment grid displaying "Per Return" and "Per Exam" amounts.

  3. The administrative lead sheets listed below are mandatory for revenue agents and are generally applicable to all income tax cases:

    1. 110, Revenue Agent Audit Plan,

    2. 115, Group Manager Concurrence Meeting (mandatory for GS-12 and below),

    3. 120-1, Initial Taxpayer Contact,

    4. 125-2, Initial Interview and Notes,

    5. 130, Multi-Year and Related Returns,

    6. 200, Internal Controls (business returns only),

    7. 300, Civil Penalty Approval Form, and

    8. 400, Minimum Income Probe.

      Note:

      If gross receipts are classified, the examiner must add the issue as a "Classified Issue" (RGS will assign a number in the 4XX series). If gross receipts are not classified, but are examined, the examiner must add the issue as a "New Issue" (RGS will assign a number in the 5XX series). See IRM 4.10.15.2.9, Issues, for additional guidance.

  4. The administrative lead sheets listed below are mandatory for tax compliance officers and tax auditors and are generally applicable to all income tax cases.

    1. 110, Tax Compliance Officer Audit Plan,

    2. 125-1, Initial Taxpayer Contact-TCO,

    3. 125-2, Initial Interview Questions and Notes,

    4. 125-3, Initial Interview Questions and Notes Business Supplement, for returns with Schedule C or F,

    5. 130, Multi-Year and Related Returns,

    6. 200, Internal Controls (business returns),

      Note:

      See IRM 4.10.4.2.2, Business Returns, and IRM 4.10.4.3.3.4, Evaluation of Internal Controls (Individual Business Return).

    7. 300, Civil Penalty Approval Form, and

    8. 400, Minimum Income Probe.

      Note:

      If gross receipts are classified, the examiner must add the issue as a "Classified Issue" (RGS will assign a number in the 4XX series). If gross receipts are not classified, but are examined, the examiner must add the issue as a "New Issue" (RGS will assign a number in the 5XX series). See IRM 4.10.15.2.9, Issues, for additional guidance.

4.10.9.6.2  (08-11-2014)
Issue Lead Sheets

  1. Issue lead sheets are used to:

    1. Document the adjustments, conclusion, audit steps, facts, law, and taxpayer's position for examined issues, and

    2. Index and reference supporting workpapers.

  2. In general, issue lead sheets contain an adjustment grid that displays a "Per Return" , "Per Exam" , and "Adjustment" amount. However, there are some issues that do not result in an adjustment to the tax return (e.g. innocent spouse and identity theft), and as a result the related issue lead sheet does not contain an adjustment grid.

    Note:

    All issues must be listed on Form 4318 or Form 4318-OA

    .

  3. An issue lead sheet is required for all issues. If an issue does not have a specific lead sheet, a generic lead sheet must be used. See IRM 4.10.15.2.14, Lead Sheets, for additional information.

  4. The examiner or group manager should document all managerial discussions on the relevant issue lead sheet or on Form 9984.

4.10.9.6.2.1  (08-11-2014)
Issue Lead Sheet Format

  1. Issue lead sheets should contain the following:

    1. Header - See IRM 4.10.9.7.1.

    2. Content - See IRM 4.10.9.6.2.2.

    3. Footer - See IRM 4.10.9.7.1.

4.10.9.6.2.2  (08-11-2014)
Issue Lead Sheet Content

  1. Issue lead sheets must reflect the issue name, adjustments (when applicable), conclusion, audit steps, facts, law, and taxpayer's position in the body. This information should be presented in a logical order so reviewers can easily determine what audit steps and actions were taken to support the conclusion.

    1. Adjustments -- Document the adjustments resulting from the audit. The lead sheet will detail the "Per Return," "Per Exam," and "Adjustment" amounts with each adjustment referenced to the supporting workpapers.

    2. Conclusion -- Document a conclusion summarizing the disposition of each issue.

    3. Audit Steps -- Document references to the supporting workpapers that contain the procedures and the audit techniques performed during the audit.

      Note:

      Issue-specific lead sheets are designed with suggested audit steps that are applicable to the issue. Examiners should customize the audit steps for their specific case. Steps that are not applicable should be deleted and additional steps should be added when warranted.

    4. Facts -- Document 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.

    5. Law -- Document the applicable law relied upon to resolve the issue (both no change and adjusted issues). The applicable law should be correctly cited and explained (if necessary). Rulings, opinions, and decisions relied upon should be clearly stated and identified in the explanation. If the adjustment is supported by multiple code sections of tax law, they all must be reflected. For example, to support a disallowance of business expenses, IRC 162(a), ordinary and necessary business expenses, and IRC 6001, lack of substantiation, should be incorporated into the narrative, if both are applicable.

    6. Taxpayer's Position -- Document the taxpayer's position. The taxpayer’s position should be stated objectively (in narrative form) if known. The legal authority, if any, that the taxpayer used as the basis of their argument should also be cited. If the taxpayer provided a written position statement, include and index it with the workpapers. If the taxpayer does not provide a position, the examiner should document that fact in this section of the lead sheet.

4.10.9.7  (08-11-2014)
Workpapers

  1. Workpapers support the information included on the lead sheets and, when applicable, should reflect:

    1. What the examiner reviewed, requested and inspected to audit the issue. At a minimum, the workpapers should explain why the issue was audited, how a sample size was determined (when applicable), and what documents were requested and inspected.

    2. Specific expenditures examined, verified and the conclusions reached. At a minimum, the workpaper should identify the amount examined, verified and the documents inspected (invoices, check numbers), as well as date and payee.

    3. Questions or items raised during the audit and the conclusions reached.

    4. Photocopies of relevant documents secured from the taxpayer and/or representative. Care should be given to consider the facts and circumstances of a particular case when determining relevance. For example, bank statements would be relevant when they are used to propose an adjustment to income.

    5. Internal source documents (e.g. Information Return Program (IRP) or Computer Files On Line (CFOL)). For example, IMFOLI/BMFOLI to support conclusions related to prior/subsequent/related return filings.

    6. Issue-specific correspondence from the taxpayer and/or representative.

  2. Many customers will use the case file; therefore, the quality and legibility of the workpapers are very important. In most instances, workpapers are prepared using computerized software. Workpapers generated using a computer provide a product with a professional appearance. When it is necessary to prepare handwritten workpapers and supporting details, they must be legible.

  3. Examiners should use their computer to prepare workpapers and reports in a way that will most efficiently and effectively document the audit process.

  4. The appearance of the workpapers reflects the professionalism and skills of the examiner. Poorly prepared workpapers can adversely impact the Service's credibility. Additional reasons workpapers should be neat, legible, and grammatically correct are:

    1. To assist in preparing reports.

    2. Possible use in a court of law many months or years later. In a litigated case, the workpapers become court exhibits. As a witness in the case, the examiner must rely on his or her workpapers to answer questions regarding actions taken and conclusions reached.

    3. Taxpayer requests for workpapers or the case file.

    4. Efficient transfer of the case in the event the original examiner is unavailable. The new examiner must rely on the workpapers to develop issues that have already been identified, and continue the exam without duplicating actions.

    5. Potential use in a subsequent audit.

    6. Potential reviews performed by managers, Technical Services, Appeals, the Taxpayer Advocate Service (TAS), Interest Abatement Coordinator, TIGTA, Government Accounting Office (GAO), etc.

    7. Facilitate closing by Centralized Case Processing (CCP).

  5. To ensure workpapers are neat, legible, grammatically correct, and easily understood the examiner should:

    1. Use vocabulary that is easily understood;

    2. Avoid using jargon (use common terms in place of legal jargon);

    3. Provide explanations when acronyms are used the first time;

    4. Verify that spelling and punctuation are correct (use spell-checker and grammar-checker if available);

    5. Prepare workpapers contemporaneously to avoid unnecessary rewriting; and

    6. Ensure photocopied and scanned workpapers and other documentation are legible.

  6. Workpapers should be assembled in uniform size. If odd sized paper or documents are included, they should be folded to the appropriate size. Adding machine tapes or other small size documents should be attached to uniform-sized sheets of paper.

4.10.9.7.1  (08-11-2014)
Workpapers: Headers and Footers

  1. Workpapers must include a header and footer with the following information:

  2. Header Information:

    1. Taxpayer's name,

    2. Taxpayer identification number,

    3. Tax return form numbers and years examined,

    4. Examiner's name (or initials), and

    5. Date workpaper was prepared.

      Note:

      If a workpaper is prepared on multiple dates, the examiner should note each date that significant work was done.

  3. Footer Information - Indexed page number.

4.10.9.7.2  (08-11-2014)
Workpapers: Indexing

  1. All workpapers should be numbered. For example, if the issue lead sheet reflects "Bad Debt Expense" as Issue 402, then the workpapers associated with the issue should be numbered in chronological order as 402-1.1, 402-1.2, 402-1.3, 402-2.1, etc. In addition, see IRM 4.10.15.1.4 (5), for guidance regarding naming files within RGS.

  2. Workpapers should be prepared using appropriate cross-referencing as follows:

    1. Examiners should use the "Workpaper Reference" column on the administrative or issue lead sheet to point to the supporting workpaper(s). The supporting workpaper(s) contain the documentation to explain the work performed.

    2. It is not necessary to cross-reference all supporting workpapers to the lead sheet, however, supporting workpapers should be cross-referenced to each other when necessary to document the audit trail.

  3. Tick marks are used to simplify documentation of conditions found and work performed. Tick marks do not need to be standardized throughout the case file, but they must be consistent throughout the workpapers for an issue. Tick mark explanations must be a part of the workpaper or included in a separate tick mark legend workpaper.

  4. Workpapers should be indexed contemporaneously throughout the audit.

  5. Document 12278, Examination Workpaper Index Reference Tabs, should be used by revenue agents to help index audit lead sheets and workpapers to the Form 4318. Generally, the information on each tab identifies the numeric index and the associated lead sheet as depicted on the Form 4318.

  6. Document 13005, Office Examination Workpaper Index Reference Tabs, should be used by TCOs to help index audit lead sheets and workpapers to the Form 4318-OA. Generally, the information on each tab identifies the numeric index and the associated lead sheet as depicted on the Form 4318-OA.

4.10.9.7.3  (08-11-2014)
Workpapers: Disclosure

  1. A taxpayer and/or representative can request and receive information from the examiner. Documents in the case file can be released unless the disclosure would seriously impair tax administration. Refer to IRM 4.2.5.7, Requests for File and Workpapers.

  2. Sensitive but Unclassified (SBU) information related to the case must be safeguarded from unauthorized disclosure. If an examiner determines that information contained in a case is SBU, the information should be placed in a "To be Opened by Addressee Only" envelope inside the case file.

  3. When a case file contains SBU information, Form G TDF 15-05.11, Sensitive But Unclassified (SBU) Cover Sheet, must be attached to the front of the case file. This will alert users there is SBU information in the file requiring protection.

  4. If a Freedom of Information Act (FOIA) request is received on a case that contains SBU information, a Disclosure Officer will determine if any information can be redacted. See IRM 11.3.13.7, Review and Redacting, for additional information.

  5. Examiners should keep their files clean of unrelated materials. For example, when examiners print information from services such as yK1, they should immediately discard all material on unrelated parties unless such information is functionally declared necessary (e.g., to detail specific search methodology). See IRM 11.3.17.7, Privacy Act Requirement to Maintain Accurate, Relevant, Timely and Complete Records, for additional guidance.

4.10.9.7.4  (08-11-2014)
Workpapers: Documenting Pre-Plan

  1. Examiners should pre-plan the case as outlined in IRM 4.10.2.3, In-depth Pre-Contact Analysis. All pre-plan actions taken should be documented and any applicable lead sheets completed to the extent possible.

  2. Examiners should document taxpayer and representative contact made to schedule the initial appointment. Contact information in RGS should be updated, if necessary, based on the initial taxpayer contact.

4.10.9.7.5  (08-11-2014)
Workpapers: Documenting Initial Interview

  1. A well-documented interview provides an understanding of the taxpayer's financial history, business operations, and accounting records.

  2. Interview questions must be tailored to gain a clear understanding of the taxpayer, as well as the operations of the taxpayer.

  3. Examiners should take brief notes during the interview and note those areas which need additional development. Extensive note taking can be distracting and hinder the flow of the interview. It is important that the examiner maintain eye contact with the taxpayer during the interview. Immediately following the interview, the examiner should use their notes to prepare a memorandum or summary of the interview. The memorandum or summary of the interview should not duplicate the interview notes.

  4. Audit Technique Guides (ATG) contain suggested interview questions for specific industries and issues. This information may be helpful in planning the interview. ATGs are available at http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Audit-Techniques-Guides-ATGs .

  5. IRM 4.10.3.2.5, Documenting Interviews, discusses the elements of an adequately documented interview and should be referenced when preparing for the interview.

4.10.9.7.6  (08-11-2014)
Workpapers: Documenting Tour of Business

  1. Examiners should document their observations when a tour of business or other appropriate site inspection is conducted. The tour should be documented in sufficient detail to explain what was observed and any conclusions reached. See IRM 4.10.3.3, Tours of Business Sites, and IRM 4.10.3.3.6, Case File Documentation.

4.10.9.7.7  (08-11-2014)
Workpapers: Documenting Issues

  1. All information critical to the case or that supports an adjustment must be included in the paper case file, including lead sheets, supporting workpapers and any other pertinent documents. Whenever possible, examiners are encouraged to include all information critical to the case or that supports an adjustment in the RGS electronic case file as well. Examiners need to use good judgment when including information in the RGS electronic case file and determining whether the documents add merit or value to the case. See IRM 4.10.15.1.4, Documents Included in RGS, for additional information.

  2. When available, the taxpayer’s electronic accounting software backup data file (e.g., QuickBooks®, Sage®, Peachtree®) is used to create a spreadsheet that contains numerous financial statement reports (e.g., trial balance, general ledger, journal, etc.) that are used to conduct the audit. During the audit the examiner should determine what electronic records should be included in the case file. In many circumstances, the spreadsheet, indexed to the lead sheets and workpapers, may be sufficient to support the audit adjustments. See IRM 4.10.9.7.11.1 for additional information.

  3. Cases created using RGS require regular backup to the file server. Correspondence Examination Automation Support (CEAS) users must back up their inventory weekly to ensure the most recent data is available on the file server. Examiners are strongly encouraged to complete a backup to the file server every time RGS is accessed. An inventory backup is important to safeguard the contents of each case. When a case is backed up, all files (Word®, Excel®, Adobe®, etc.) stored within the case in RGS are included in the backup.

  4. Examiners can use various tools to assist in the preparation of workpapers. These may include word processing, database and spreadsheet applications. Examiners should use the tool that will provide the most utility and functionality in the most efficient and effective manner for the issue being addressed. The MySB/SE website is continuously updated with new releases of tax administration tools that may be helpful. This information may be found on the Issues and Procedures web page.

  5. Optional workbooks are available to assist examiners in performing various complex computations including but not limited to depreciation, net operating loss, passive activity limitations, and charitable contribution limitations. These workbooks are available on the Special Applications web page of the RGS website.

4.10.9.7.8  (08-11-2014)
Workpapers: Documenting Penalties

  1. Consideration of penalties must be documented in all audits, including those involving tax shelters and erroneous claims for refund or credit. The applicability of penalties should be considered during the audit and, if warranted, developed as the audit progresses. Only after all facts and circumstances surrounding an audit have been developed can a determination be made as to the application of appropriate penalties. See IRM 20.1.5, Return Related Penalties.

    Exception:

    The examiner must not document conclusions regarding a return preparer’s responsibility for errors and the assertion or non assertion of the return preparer penalty in the income tax case file. See IRM 4.10.9.7.10 for additional guidance.

  2. IRC 6751(a) requires that the Service provide the taxpayer with the name of the penalty, the Internal Revenue Code section under which the penalty is imposed, and a computation of the penalty on the notice (report) imposing the penalty.

  3. The assertion or non-assertion of penalties must be documented on Lead Sheet 300-1 whenever an audit results in a deficiency. The extent of the documentation will depend on the nature of the adjustments and the amounts involved. Canned statements (e.g. "negligence penalty applicable" or "negligence penalty deemed to be not applicable" ), are not sufficient.

  4. The examiner must cite the appropriate regulations, rulings and court decisions that are specific to the case’s facts and circumstances for assertion or non-assertion of penalties.

  5. Alternative penalty positions must be documented in the workpapers when applicable (e.g. fraud versus negligence penalties, and various components of the accuracy-related penalty). See IRM 4.10.8.12.5, Alternative Positions, for additional guidance.

4.10.9.7.8.1  (08-11-2014)
Penalties: Dollar Criteria

  1. The examiner must include documentation supporting assertion or non-assertion of a penalty on Lead Sheet 300-1 whenever the understatement of tax exceeds the dollar criteria for applying the penalty. Written managerial approval is also required. See IRM 4.10.9.7.8.2.

    Example:

    The assertion or non-assertion of the substantial understatement penalty under IRC 6662(d) must be addressed when the understatement exceeds the greater of 10% of the tax required to be shown on the return, or $5,000 ($10,000 for corporations other than S corporations or personal holding companies).

4.10.9.7.8.2  (08-11-2014)
Penalties: Managerial Approval

  1. IRC 6751(b) provides that prior to assessment, all cases recommending the assertion of certain penalties must have written managerial approval. The group manager must perform a meaningful review of the penalty determination.

  2. Managerial review and approval is also required on the non-assertion of penalties when there is a substantial understatement of tax under IRC 6662(d). The group manager must personally approve non-assertion of the penalty, and should document his or her involvement on Lead Sheet 300-1.

  3. Penalties requiring managerial approval must be approved before the case closes from the group. See IRM 20.1.1.2.3 (8), Managerial Approval for Penalty Assessments, and IRM 20.1.5.1.6, Managerial Approval of Penalties, for additional information.

4.10.9.7.9  (08-11-2014)
Documenting Fraud Consideration and Civil Fraud Penalty

  1. During every audit, examiners must be alert to fraud indicators and assert the civil fraud penalty when there is clear and convincing evidence to prove that some part of the adjustment to taxable income and/or credits resulting in an underpayment of tax was due to civil fraud. Such evidence must show the taxpayer's intent to evade tax, which the taxpayer believed to be due.

  2. For every case resulting in a deficiency, examiners must document their consideration of fraud, including applicable fraud indicators, even if the civil fraud penalty is not pursued or developed. See IRM 25.1.2.3, Indicators of Fraud. To document consideration of fraud when the civil fraud penalty is not pursued or developed, the examiner should check "No" in the "Assert Penalty" column for IRC 6663 and document the fraud indicators and facts supporting non-assertion of the civil fraud penalty in the "Conclusion" section on Lead Sheet 300-1.

  3. If the civil fraud penalty is pursued and developed, the examiner must use Lead Sheet 205, Fraud Development, to document the facts, law, and taxpayer's position. If the penalty is asserted, Lead Sheet 205 should also reflect the penalty amount and conclusion. Fraud indicators should be documented on Lead Sheet 205 or a supporting workpaper. In cases where the civil fraud penalty was pursued and developed, but not asserted, the examiner must explain the reasons why it was not asserted in the "Conclusion" section on Lead Sheet 205 or Lead Sheet 300-1, and cross-reference the other lead sheet.

4.10.9.7.10  (08-11-2014)
Documenting Return Preparer Penalty Consideration

  1. During every audit where the tax return was prepared by a tax return preparer, examiners must determine if return preparer penalties are warranted. See IRM 20.1.6.4.2, Tax Return Preparer Defined. This determination is based on the facts and circumstances of the case, including oral testimony and written evidence developed during the audit.

  2. Examiners must exercise caution when documenting consideration of return preparer penalties in the related income tax case because the income tax audit is separate and distinct from the return preparer penalty case. Examiners must not propose or discuss return preparer penalties in the presence of the taxpayer.

  3. When the return was prepared by a tax return preparer and the audit results in a deficiency, examiners must document consideration of return preparer penalties in the income tax case. Examiners must document the "Consideration of Preparer/Promoter/Material Advisor Penalties" section of Lead Sheet 300-1, and reference the workpapers containing the facts.

  4. The income tax case should reflect the return preparer's involvement in and responsibility for the preparation of the tax return. Documentation should be limited to the information necessary to demonstrate the return preparer’s actions, such as:

    1. Assertions by the taxpayer that penalties are not applicable because they relied on their return preparer.

    2. Factual information received from the taxpayer about the return preparation.

    3. The taxpayer’s statements about his or her interaction with the preparer.

    4. The return preparer's statements and explanations related to the preparation of the return.

  5. Examiners should not document:

    1. Information about the return preparer’s conduct gathered from other sources, or

    2. Conclusions regarding the return preparer’s responsibility for errors and the assertion or non-assertion of the return preparer penalty.

4.10.9.7.11  (08-11-2014)
Workpapers: Closing Cases with Automated Workpapers and Reports

  1. Examiners must use computer generated reports in all audits, unless a computer generated report is not available. See IRM 4.10.15.1.2.

  2. Cases required to be on RGS CEAS must be moved to the file server to close the case. All electronic workpapers saved within the RGS program automatically close to the file server. If workpapers are generated outside of any RGS application, they should be saved to the RGS electronic case folder to be saved to the file server.

  3. Cases not required to be on RGS CEAS should be copied to a Guardian Edge Removable Storage (GERS) encrypted compact disk (CD) or digital versatile disk (DVD) and the disk should be included with the case file. Document the password on Form 9984 and label the CD or DVD with the following information:

    1. Identification of disk content;

    2. Media information (software format);

    3. Employee’s name;

    4. Office; and

    5. Date created.

  4. A password must be created prior to the creation of the GERS encrypted disk. If the case is in RGS, the GERS password should be notated in Lead Sheet 100-2, External Records Password Lead Sheet, and saved in RGS Office Documents (OD).

  5. All lead sheets, workpapers and examination reports should be printed and included in the paper case file.

4.10.9.7.11.1  (08-11-2014)
Electronic Accounting Software Backup Data Files and Spreadsheets

  1. Due to the nature of the software, the electronic accounting software backup data file (e.g., QuickBooks®, Sage®, Peachtree®) may contain a significant amount of information about transactions that are not relevant to the years under audit. Generally, the electronic accounting software backup data file should not be included in the case file when the case is closed.

    Note:

    See IRM 4.10.9.7.7 (2) and IRM 4.10.9.7.11.1 (5) for information regarding the related spreadsheets.

  2. In situations where the examiner is not sure if they should include the electronic accounting software backup data file in the case file, they should consult with their group manager. Exceptions may be considered based on the facts and circumstances of the case, including:

    • Whether the case is agreed or unagreed

    • Whether the case is being closed for issuance of a notice of deficiency

    • Whether the case is a criminal or civil fraud case

    • Whether the case has complex issues

  3. Electronic accounting software backup data files are not compatible with RGS and should never be included in RGS. See IRM 4.10.15.1.4 (2). If the decision is made to include the backup data file with the case file, a GERS encrypted CD or DVD should be created to include the backup data file. See IRM 4.10.9.7.11 (4) for password instructions, and IRM 4.10.15.1.4 (9), for additional information.

  4. Original CDs, DVDs and thumb drives containing the electronic accounting software backup data files received from taxpayers should be returned to the taxpayer. If it is not feasible to return the media, proper disposal procedures should be followed as explained in IRM 2.7.4, Magnetic Media Management.

  5. If the spreadsheet containing reports created using the taxpayer’s electronic accounting software backup data file is larger than 5 MB, it should be copied to a GERS encrypted CD or DVD unless it is a critical part of the case and is needed to support the results of the examination. See IRM 4.10.9.7.11 (5) for password instructions, and IRM 4.10.15.1.4 (9), for additional information.

4.10.9.8  (08-11-2014)
Special Situations Requiring Documentary Evidence

  1. The following situations require special documentary evidence:

    1. A fiduciary relationship.

    2. A corporate name change or reorganization.

    3. A bankruptcy or receivership.

    Note:

    When special situations occur that may impact processing, examiners should notate the "Special Features - Other Instructions" section of Form 3198, Special Handling Notice for Examination Case Processing.

  2. Documentary evidence is needed to:

    1. Validate a return filed after one of the situations in IRM 4.10.9.8 (1) occurred.

    2. Determine the authority for the execution of waivers and reports.

    3. Determine the authority for the execution of a consent to extend the time to assess tax.

    4. Determine the authority to receive refunds.

  3. To the extent the required documentation is not already attached to the return, examiners should secure the following documentary evidence:

    1. To verify a fiduciary relationship for a decedent, obtain Form 56, Notice Concerning Fiduciary Relationship, and Form 1310, Statement of Person Claiming Refund Due a Deceased Taxpayer, where a refund is due. Form 1310 should also be secured when only one of the taxpayers filing a joint return is deceased. Examiners must also secure a certified copy of the legal document giving the fiduciary authorization to act for the taxpayer. These legal documents include letter of testamentary and letter of guardianship.

    2. When a corporation's name has changed or a corporation has reorganized, the examiner must obtain copies of documents certifying the changes filed with, or received from, the state in which the successor corporation is incorporated.

    3. If a bankruptcy or receivership is involved, secure the name of the party legally entitled to any refund which may be due. See IRM 4.4.3.7, Refunds to Other Taxpayers, for guidance.

4.10.9.9  (08-11-2014)
Case File Assembly for Closing

  1. Proper assembly of a case file helps to minimize delays, administrative problems and procedural errors.

  2. Each case should be placed in a separate folder. A case constitutes all examined returns and workpapers with the same type of tax for the same taxpayer. Within the folder, the oldest year should be placed on top, followed by the other years in order, with the most current year on the bottom.

  3. All related case folders should be kept together with the key case folder on top. Form 3198 is required for the key and each related case. The examiner must record the related or key case in the "Related Taxpayers or Key Cases" section of Form 3198.

  4. If more than one folder is used to hold returns, workpapers, or related cases, they should be numbered to ensure they are not separated in error. For example, if there are three folders for one case, number the folders "1 of 3" , "2 of 3" , and "3 of 3" .

  5. Examiners must follow the instructions listed in this section for:

    1. Forms attached to the outside of the case folder. See IRM 4.10.9.9.1.

    2. Forms attached to the inside left of the case folder. See IRM 4.10.9.9.2.

    3. Forms and other documents enclosed within the case folder. See IRM 4.10.9.9.3.

    4. Forms and other documents to be attached to tax returns. See IRM 4.10.9.9.4.

  6. The forms, reports and/or documents listed below will not be required in every case. While the list is not all inclusive, it addresses the most common items.

4.10.9.9.1  (08-11-2014)
Forms on the Outside of the Case Folder

  1. When the following forms and documents are required, they must be attached to the outside of the case folder and placed in the following order (top to bottom):

    1. Form 3210, Document Transmittal;

    2. Form 895, Notice of Statute Expiration (the case must be placed in a red folder if there are 180 days or less remaining on the statute);

    3. G TDF 15-05.11, Sensitive But Unclassified (SBU) Cover Sheet (this cover sheet clearly identifies cases and documents that must always be under the personal observation of an authorized IRS employee or maintained in a secured cabinet);

    4. Form 3185, Transfer of Return;

    5. Form 3198;

      Note:

      For cases with agreed and unpaid deficiencies over $100,000, examiners must check the "Over $100,000 Agreed and Unpaid" box in the "Expedite Processing" section.

    6. Form 10329, Transmittal Sheet-Related Cases (companion to Form 3198).

4.10.9.9.2  (08-11-2014)
Forms on the Inside Left of the Case Folder

  1. Forms and documents to be attached to the inside left of the case folder should be assembled in the following order (top to bottom):

    1. Form 2363, Master File Entity Change;

    2. Form 885-E, Schedule for FICA Tax Adjustment of Wages Not Previously Reported (or RGS equivalent);

    3. Form 885-T, Adjustment of Social Security Tax on Tip Income Not Reported to Employer (or RGS equivalent);

    4. Form 6657, Related Returns Examination Report;

    5. Form 5346, Examination Information Report;

    6. Form 3699, Return of Documents to Taxpayer;

    7. Information On Line Entity Summary (INOLES), Audit Management Display System All (AMDISA), and a TXMODA (current within 30 days of closure);

    8. CDs or DVDs enclosed in protective jacket(s), when necessary.

4.10.9.9.3  (08-11-2014)
Forms and Other Documents Inside the Case Folder

  1. In order to create a well organized, professional appearing case, the lead sheets and workpapers in the case folder should be arranged in packages (groups). The packages should be clipped or stapled together and placed inside the case folder in the following order (top to bottom).

    1. Form 9440, Taxpayer Levy Source and Contact Information. See IRM 4.20.3.3, Securing Collection Information - Form 9440.

    2. Waiver and acceptance forms, such as:
      Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment;
      Form 875, Acceptance of Examiner's Findings By A Partnership, Fiduciary, S Corporation, or Interest Charge Domestic International Sales Corporation;
      Form 886-S, Partners' Share of Income, Deduction and Credits;
      Form 886-X, Shareholders' Shares of Income, Deductions, and Credits;
      Form 886-Z, TEFRA Partners' Shares of Income;
      Form 2297, Waiver of Statutory Notification of Claim Disallowance;
      Form 2504, Agreement to Assessment and Collection of Additional Tax and Acceptance of Overassessment;
      Form 3363, Acceptance of Proposed Disallowance of Claim for Refund or Credit.

    3. Form 4665, Report Transmittal.

    4. Form 3999, Statute Expiration Report.

    5. Taxpayer's protest and correspondence in unagreed cases.

    6. Form 3213, Engineer Memorandum Report.

    7. Form 3963, International Examiner’s Report.

    8. Examination report with appropriate attachments (agreed or unagreed).

    9. Form 433-D, Installment Agreement, Form 9465, Installment Agreement Request, and Form 2159, Payroll Deduction Agreement, must be placed on top of Form 5344.

      Note:

      When any of these forms are enclosed in a case file, Form 3198 should be flagged so CCP will remove the form and send it to the appropriate Campus.

    10. Original tax return(s) or electronic prints if used in lieu of the original return and related attachments or CC ESTAB/ELFREQ prints reflecting the requesting of the original return. The oldest tax period should be on the top and progress down to the most current year.

    11. Form 4318, or Form 4318-OA — these forms will be the first page with additional workpapers to follow. If a prior audit or adjustment occurred, the most current workpapers should be on top. See IRM 4.10.9.4, for additional guidance.

4.10.9.9.4  (08-11-2014)
Forms and Documents Attached to Tax Returns

  1. Form 5344, Examination Closing Record (one for each tax period), must be attached to the face of the return.

    Note:

    If partially agreed, see IRM 4.10.8.5.

    Note:

    If the return you are closing must be recharged to a specific location, complete Form 2275, Records Request, Charge and Recharge, and place it on top of Form 5344. Form 3198 must contain instructions regarding where to send (recharge) the return.

  2. Compliance Evaluation print out. See IRM 4.10.16.1.2.5, Completion of the Compliance Evaluation Screen.

  3. Form 1900, Income Tax Survey After Assignment.

  4. Form 3244-A, Payment Posting Voucher - Examination — must be attached to first page of return.

  5. Consents to extend the time to assess tax, including Form 872, Form 872–A, Form 872–B, Form 872–F, Form 872–O, or Form 872–N, Notice of Termination of Special Consent to Extend the Time to Assess Tax, if initiated by the taxpayer — staple one of the two executed copies to the reverse of the first page of the tax return on top of any other attached forms.

  6. A copy of an executed Form 872-T, Notice of Termination of Special Consent to Extend the Time to Assess Tax, mailed to or received from the taxpayer must be attached to the back of the first page of the tax return to which it applies. See IRM 25.6.22.7.1.6, Location of Executed Form 872-T.

  7. Form 56, Notice Concerning Fiduciary Relationship — staple to reverse of the first page of the tax return.

  8. Form 1310, Statement of Person Claiming Refund Due a Deceased Taxpayer.

  9. Form 2848, Power of Attorney and Declaration of Representative —staple to reverse of the first page of the tax return.

  10. Form 8821, Tax Information Authorization.

  11. Form 843, Claim for Refund and Request for Abatement, Form 1040X or Form 1120X, amended returns.

  12. Form 1045, Application for Tentative Refund, or Form 1139, Corporation Application for Tentative Refund —staple to tax return giving rise to tentative carryback adjustment. Attach a copy of Form 1045 or Form 1139 to each carryback/carryforward year.

  13. Form 906, Closing Agreement on Final Determination Covering Specific Matters.

  14. A photocopy of requests (e.g., Form 5345-D, Examination Request-ERCS (Examination Returns Control System) Users , Form 5346, or Form 5354, Examination Request Non-Master File) using the following source codes must be attached to the returns as a permanent record:

    • Source Code 45 reference and information return

    • Source Code 60 examination information report

    • Source Code 99 Other

  15. Form 5546, Return Charge Out Sheet, and applicable transcripts.

  16. Form 2198, Determination of Liability for Personal Holding Company Tax.

4.10.9.10  (08-11-2014)
Mailing Cases

  1. Form 3210, Document Transmittal, must be used and should identify each taxpayer and each tax period when a case is mailed. Include the Area's primary business code (PBC) in the "Remarks " section (e.g. "Area XXX)" .

  2. Each case should be secured with a rubber band or strap. All related cases should be grouped together with rubber bands, straps, or boxed together, as appropriate.

  3. When mailing cases, the procedures in IRM 10.2.13.4.4.1, Shipping Personally Identifiable Information (PII), must be followed.

  4. RGS case data should be closed when the paper case file is shipped.


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