4.22.3  Classification of NRP Returns

Manual Transmittal

December 27, 2011

Purpose

(1) This transmits a revision of IRM 4.22.3, Classification of NRP Returns.

Material Changes

(1) This IRM was updated to change Large and Mid-Size Business (LMSB) to Large Business and International Division (LB&I), and edits to Exhibit 1.

Effect on Other Documents

None

Audience

Small Business/Self-Employed (SB/SE) and Large Business and International Division (LB&I) Examination employees.

Effective Date

(12-27-2011)

William W. Hannon
Director, National Research Program

4.22.3.1  (10-01-2011)
General Classification Guidelines

  1. This IRM contains information related to the classification of NRP key case tax returns. NRP key case returns are defined as AIMS Source Code 80 tax returns.

  2. In the NRP classification process, every item on the return and on all attachments will be considered, regardless of materiality or tax impact. There is no limit to the number of issues that may be classified for NRP. In classifying a Form 1040 return, the presence of a Collectibility Indicator will not be a consideration to accept a return as filed.

  3. Classifiers will not classify returns they may examine. If they receive a return to classify that they may be required to examine, they will immediately return it to their NRP Coordinator or classification coordinator for redistribution.

  4. Classifiers will first review each return in its entirety for a general impression of interrelationships among the income, expenses, credits and any other items. This review will include elections, schedules, and any documents attached to the return. The classifier can evaluate the significance of individual items and use the appropriate case building material to identify items that are potentially inaccurate and eliminate those with no potential for change.

  5. Classifiers will compare the return to the transcripts (IMFOL or BMFOL) in the case building information. This will verify whether the return has been amended or adjusted. The classifier will make an entry in the "Case Related Comments" section of the Classification Return Form to alert the examiner to order any other required returns or information.

  6. Generally, all Large, Unusual and Questionable (LUQ) issues (defined in IRM 4.10.2.3.1) will be classified for examination. In considering whether an issue is LUQ, the classifier will judge whether there is a high probability, based on their knowledge and experience, that the item is correct. If in doubt, the item will be classified.

  7. When warranted, the classifier should identify and classify related, prior and subsequent year returns for examination. They will check all case related documents to determine whether the taxpayer has filed all required returns. The examination will also include checks for filing of information returns. The classifier will make an entry in the "Case Related Comments" section of the Classification Return Form to alert the examiner to order any other required returns or information.

4.22.3.1.1  (10-01-2011)
Case Building and Reference Information

  1. The NRP classification process uses extensive case building materials. Classifiers will use the information to help determine which issues to classify. In addition to the original paper return or the e-filed return facsimile (TRPRT return print), case building materials include the following (depending on the tax return form being classified):

    1. Case Building Inventory Sheet

    2. Examination Return Charge-Out (Form 4251 or 5546)

    3. 3-year Compliance Data Environment (CDE) print

    4. ChoicePoint

    5. IDRS (various command codes, including IRPTR)

    6. yK-1 print

    7. Schedule K-1’s

    8. Other Case Information

  2. Many tax return entries can be corroborated using the case building material-primarily the IRP information. If the information included in the case building material matches the items reported on the tax return, generally the item will not be classified. This includes Form W-2 income, Form 1099 information, and mortgage interest on Form 1098.

  3. Because NRP classification is conducted using a computer connected to the LAN, classifiers may use any research tools, reference materials, or job aids available to them through various internal and external web sites. This information would include:

    1. IRS Processing Codes and Information (Document 6209)

    2. Examination Division Reporting System Codes Booklet (Document 6036)

    3. Internal Revenue Code and Regulations

    4. Tax Forms and Publications

4.22.3.1.2  (10-01-2011)
Classification Review

  1. Initially, all classified NRP returns will be reviewed. The Area NRP Coordinators will serve as the classification reviewers. They will review the initial returns of each classifier with the goal of consistent application of the classification guidelines and also for consistency between classifiers. Classifiers will receive feedback from the classification reviewer on their work.

  2. After the Coordinator/reviewer is satisfied as to the quality and consistency of each classifier’s returns, classification review will be reduced to an overall 10% sample of returns classified during the classification session. Quality and consistency of classification will be stressed.

  3. All classified NRP returns selected as "Accepted as Filed," "Accepted with Adjustments" and "Correspondence" will be reviewed. Also, the reviewers will verify any classified return where the classifier has made a change to a "Per Database" item on the Classification Return Form.

  4. At the conclusion of the classification detail, the reviewers will provide each classifier with a written non-evaluative assessment of their work on the assignment.

4.22.3.1.3  (10-01-2011)
Classification Scope; Examination Depth

  1. The classifier will determine the minimum scope of the examination. If an issue is selected by the classifier, the classified issue will be entered into the RGS system prior to the return being received by the examiner.

  2. The examiner will determine the depth of the selected issues. During the examination, the examiner must examine or specifically comment on each classified issue in the RGS system. The examiner will expand the examination as necessary to perform a quality examination.

4.22.3.1.4  (10-01-2011)
Missing Forms, Schedules or Line Items

  1. The classifier should identify if the return is complete and whether it contains all necessary forms and schedules. Any forms or schedules identified by the classifier as missing should be classified on the appropriate line item of the Classification Return Form. If the line item cannot be determined, the classifier should use the "Case Related Comments" section of the Classification Return Form to describe the missing item.

  2. The classifier should always look for and consider missing line items. They will classify and document all potential missing line items on the appropriate line item of the Classification Return Form and provide information in the "Comments" box of the classified issue.

4.22.3.2  (10-01-2011)
NRP Classification of Form 1040 Returns

  1. The information in this section applies to the classification of NRP Form 1040 Individual tax returns. This information also covers Forms 1040A and 1040EZ.

  2. NRP Classification Guidelines Training contains in-depth information and instructions for classifiers on the classification of the selected NRP returns. The training also provides instructions for accessing and using the NRP Classification System.

4.22.3.2.1  (10-01-2011)
Completion of the NRP Form 1040 Classification Return Form

  1. There are three different NRP 1040 Classification Return Forms that will display depending on the type of return filed – 1040, 1040A or 1040EZ. They will appear similar to the actual return filed and will include all schedules and forms applicable to the classification process.

  2. The issues identified by the classifier during their input on the Classification Return Form will be used to create issues within RGS. The classification process generates a Classified Issues List (including any comments made by the classifier) that is placed in RGS Case File Documents. Paper classification checksheets no longer exist for NRP 1040 tax returns.

  3. The NRP Form 1040 Classification Return Form is completed (and possibly reviewed) using a computer. Specific instructions for accessing and using the automated NRP 1040 Classification System are provided to classifiers and reviewers in training. The classification data will be accumulated for analysis and used to populate the classified items in RGS prior to the returns being sent to the Area PSP or Campus for audit.

  4. The NRP Classification Return Form is accessed through a secure web site. When accessed and after the Social Security Number of the taxpayer is entered, the automated NRP Classification System will pre-populate the heading information on the Classification Return Form including the Taxpayer Identification Number (TIN), name and address. The classifier's SEID number and Date Classified will be captured by the system. If the classified return is reviewed, the Classification Reviewer’s SEID and Date Reviewed will be captured.

  5. The Classification Return Form will display the dollar amounts as shown on the actual tax return. Every item with an amount other than zero must be reviewed and a classification determination must be made. During classification of the return, the classification determination of each item will be shown as "Verified," "Classified," "Not LUQ," or "NOT CLASSIFIED." If "NOT CLASSIFIED" is present, the classifier must select the item and choose the correct determination.

  6. In addition to classifying the line items on the return, the classifier will also select one of the "Classification Results" buttons (Accepted as Filed, Accepted with Adjustments, Correspondence, TCO or RA).

  7. Classifiers should use the "Comments" box to provide additional information regarding the classified issue for the examiner and the classification reviewer. They should make reference to any specific case building document used in classification.

  8. There are several issues on the Classification Return Form that require the classifier to select whether the item pertains to the primary or secondary Social Security Number (or both). "P" refers to the first (primary) Social Security Number listed on the return and "S" refers to the second Social Security Number on the return.

4.22.3.2.2  (10-01-2011)
Specific Guidelines for Classifying Forms and Schedules

  1. Following are some specific guidelines to help identify the mandatory and most prevalent issues to be classified. Detailed line item classification instructions are provided to the selected NRP classifiers during classification training.

4.22.3.2.2.1  (10-01-2011)
Earned Income Credit (EIC) and Related Issues

  1. The examination and documentation of the Earned Income Credit is an integral part of an NRP Form 1040 study. Most returns claiming EIC will be examined by Area examiners in a face-to-face setting. Examiners receive additional NRP training that provides them with the information necessary to fully examine and document this issue. In addition, there are several NRP Lead Sheet questions that are related to capturing the audit information on these returns.

  2. If the Earned Income Credit is claimed on the return it will always be classified.

  3. In order to classify EIC, the issues that give rise to the credit are the ones that are actually selected on the Classification Return Form. These issues are:

    • Exemptions: Dependent Children Who Lived with TP

    • Exemptions: Dependent Children Who Did Not Live With TP

    • Exemptions: Other

    • EIC for Qualifying Children (Not Listed as Dependents)

    • EIC With No Children

  4. When EIC is classified and the above issues are selected, the classifier will also select any or all of the issues that may be related to EIC including:

    • Dependents

    • Filing Status

    • Child and Dependent Care Credit

    • Credit for the Elderly or the Disabled

    • Education Credits

    • Child Tax Credit

    • Adoption Credit

4.22.3.2.2.2  (10-01-2011)
Income Issues

  1. In general, every income item on the return that cannot be substantiated by case building materials is classified.

  2. Generally, the IDRS IRPTR data is the best source of case building information for verifying an income amount on a given tax return line item. IRP data can be used to verify wages, interest, dividends, and miscellaneous income. The IRP data will also verify flow-through amounts from Forms 1065, 1120S and 1041.

  3. Schedule C and Schedule F income items will always be classified even when verified by IRP.

  4. Schedule B, Schedule D, and Schedule E income items will be classified unless they can be verified by case building. Additionally, these income items should be classified if there is a potential for unreported income even when the amounts are verified by case building.

  5. In using the IRP documents to verify amounts reported on the tax return, the classifier may disregard a specific mismatch if it is very small and appears to be a rounding discrepancy.

  6. Income items will also be classified if the taxpayer’s occupation provides a likely opportunity for moonlighting, receipt of tips, bartering, constructive dividends, etc.

  7. The classifier will consider indications on the return that the taxpayer(s) had insufficient income to support their standard of living. For example, if gross itemized deductions exceed Adjusted Gross Income, income should be classified. If the classifier questions whether the taxpayer(s) has enough income to sustain their apparent lifestyle, they will classify the "Other Income" issue and provide notes in the "Comments" box. The classifier may suggest "Indirect Method" if they believe that examination step is applicable.

4.22.3.2.2.3  (10-01-2011)
Large, Unusual or Questionable (LUQ) Criteria

  1. All Large, Unusual, or Questionable (LUQ) items on the return will be classified for examination. There are very few exceptions to this rule. The LUQ criteria are applied to most line items including those for income, deductions, adjustments, and credit items. LUQs are items that appear on the return which, if left unexplained, might raise doubt or cause confusion to a reviewer of the completed examination.

  2. The definition of an LUQ item will depend on the classifier’s perception of the return as a whole and the separate items that comprise the return. Some factors to be considered when identifying LUQs are the comparative size of the item, the absolute size of the item, the inherent character of the item, evidence of intent to mislead, etc.

4.22.3.2.2.4  (10-01-2011)
Filing Status – Head of Household

  1. All NRP returns filed with a filing status of Head of Household will be classified.

4.22.3.2.2.5  (10-01-2011)
Net Operating Loss Deduction

  1. If the NRP return claims a Net Operating Deduction under Other Income, it will always be classified.

4.22.3.2.2.6  (10-01-2011)
Foreign Tax Credit

  1. This issue is classified if an IRP discrepancy exists. If the issue is classified and the "Per Database" amount meets the established referral criteria, the classifier must state in the "Comments" box that there is a "Mandatory International Referral."

4.22.3.2.2.7  (10-01-2011)
Schedule A - Itemized Deductions

  1. Every item on Schedule A (Itemized Deductions) will be classified using a very low LUQ threshold. Line items will not be classified that can be corroborated by case building information.

  2. Classification of Itemized Deductions using a very low LUQ threshold is the most significant exception to classifying items as generally LUQ. Because of the great number of taxpayers that itemize their deductions, even small differences between what was reported on the return and what the correct figure is after examination is extremely significant for NRP research purposes.

  3. The classifier will not consider total itemized deduction phase-out rules based on income. For Schedule A deductions limited by AGI (Medical and Dental Expenses, Job Expenses and Certain Miscellaneous Deductions), the items will be classified after the AGI limitation is taken into account.

  4. Home Mortgage Interest and Points deducted on Schedule A can be verified from Form 1098 information on the IRP document. Because some taxpayers may be limited in the amount of their allowable deduction, classifiers are instructed to classify this issue if it is a high dollar amount rather than accept the amount claimed because it matches the Form 1098 amount.

4.22.3.2.2.8  (10-01-2011)
Employee Business Expenses – Form 2106/Form 2106-EZ

  1. Employee Business Expenses from Form 2106 or Form 2106-EZ are classified using a very low LUQ threshold. The classifier will designate whether the schedule pertains to the primary or secondary Social Security Number or both.

4.22.3.2.2.9  (10-01-2011)
Schedule C/Schedule C-EZ – Business Income or Loss

  1. Income items on Schedule C (Profit or Loss From Business) and Schedule C-EZ (Net Profit From Business) will always be classified regardless of their amount, even if the amounts match IRP documents. Expenses on these schedules (including Cost of Goods Sold) will generally be classified using the LUQ criteria. The classifier will designate whether the schedule pertains to the primary or secondary Social Security Number or both.

  2. If the classifier believes the Schedule C they are classifying may not be engaged in for a profit, they will classify the issue under "Section 183 – Not for Profit Activity" . The classifier will also classify "Interest – Mortgage" and "Taxes and Licenses" . These expenses are classified as they may be claimed on the Schedule C but may be allowable on Schedule A.

4.22.3.2.2.10  (10-01-2011)
Schedule D – Capital Gains and Losses

  1. In general, all line items on Schedule D are classified using the LUQ criteria. However, any IRP discrepancies will also be classified.

  2. All Like-Kind Exchanges will always be classified. This is true whether the return was filed with Form 8824 or not.

4.22.3.2.2.11  (10-01-2011)
Schedule E – Income or Loss From Rental Real Estate, Royalties, Partnerships, S Corporations, etc.

  1. On Schedule E Part I (Supplemental Income and Loss - Rental Real Estate and Royalties), income items will be classified unless they can be corroborated by case building information. Expenses will generally be classified using the LUQ criteria with the exception of Mortgage Interest which must be verified using case building information.

  2. On Schedule E Part II (Income or Loss From Partnerships and S Corporations), the classifier will classify any Partnership or S Corporation return that does not reconcile to the IRP document provided in the case building materials. Classifiers will identify any other flow-through entity for examination using the LUQ criteria. They will consider whether the taxpayer exercises control or significant influence over the entity, the taxpayer’s percentage ownership of the entity, whether the flow-through entity return is a first or final year return, etc.

  3. Schedule E Parts III (Income or Loss From Estates and Trusts) and IV (Income or Loss From Real Estate Mortgage Investment Conduits) will be classified similarly to Part II using LUQ criteria.

4.22.3.2.2.12  (10-01-2011)
Schedule F – Income or Loss from Farming

  1. Some Schedule F income items will be classified regardless of their amount, even if they match IRP documents. The remaining Schedule F income items will be classified unless verified by case building material. Schedule F expenses are classified using the LUQ criteria with the exception of Mortgage Interest which must be verified using case building information. The classifier will designate whether the schedule pertains to the primary or secondary Social Security Number or both.

  2. If the classifier believes the Schedule F they are classifying may not be engaged in for profit, they will classify the issue under "Section 183 – Not for Profit Activity." The classifier will also classify "Interest-Mortgage," "Interest-Other" and "Taxes." These expenses are classified as they may be claimed on the Schedule F but may be allowable on Schedule A.

4.22.3.2.3  (10-01-2011)
Classification Results

  1. The NRP tax return will be completely classified prior to the determination of the classification results. The classifier will select the appropriate issues on the Classification Return Form, review those issues against the following criteria for determining the overall result, and will lastly click the box on the Classification Return Form to indicate the Classification Results.

  2. All returns designated as "Accepted as Filed" , "Accepted with Adjustments" , or "Correspondence" will be reviewed and concurred by the NRP Coordinator or classification reviewer.

4.22.3.2.3.1  (10-01-2011)
Accepted as Filed

  1. The classified NRP return will be designated as "Accepted as Filed" if the total of all classified issues is less than the total return tolerance and there are no non-dollar items for related party transactions and there are no discrepancies related to IRP documents or processing errors.

  2. If there are issues for which dollar amounts are not known, classifiers will select the return for audit. If there is a potential issue involving a related party transaction, a sale of property, or indication that an indirect method is required to identify income, classifiers will select the return for audit.

4.22.3.2.3.2  (10-01-2011)
Accepted with Adjustments

  1. A return will be "Accepted with Adjustments" if it would have been "Accepted as Filed" except there are discrepancies related to IRP documents or processing errors.

  2. The classifier will enter the IRP discrepancy or processing error (for example, a transcription error) on the NRP 1040 Classification Return Form by selecting the appropriate issue, verifying the "Per Database" amount, and writing an explanation in the "Comments" box referring to the applicable case building document and noting the amount of the discrepancy.

4.22.3.2.3.3  (10-01-2011)
Correspondence

  1. Correspondence examiners will audit returns containing no more than five of the issues shown in Exhibit 4.22.3-1 "Correspondence Examination Issues." More than one issue in a category of similar issues may be identified on the Classification Return Form that are only counted as one issue for the total Correspondence issue count. For example, the classifier may select "Schedule A State and Local Income Taxes," "Schedule A Real Estate Taxes," and "Schedule A New Motor Vehicle Taxes." These three issues relate to the Schedule A Taxes and they are counted as only one issue towards the total Correspondence issue count.

  2. Certain IRP discrepancies where the taxpayer has underreported income may be sent to Correspondence as long as the combined total of underreported income does not exceed a low threshold amount.

  3. Earned Income Credit returns with No Children can be selected for Correspondence exam. EIC with children, any other EIC related issues, or returns with financial status concerns will not be selected for Correspondence.

4.22.3.2.3.4  (10-01-2011)
Area Examination

  1. Classifiers will select returns for Area Examination (TCO or RA) if the classified issues exceed the total return tolerances or there are non-dollar items for related party transactions or indications of potential unreported income.

  2. Returns are selected for Area Examination if they do not meet the issue guidelines for Correspondence returns. This Classification Result will be the result for the vast majority of the total returns classified.

  3. The classifier will determine whether the classified return should be assigned to a Tax Compliance Officer or a Revenue Agent. This designation by the classifier will determine the type of mandatory issues and workpapers that will be provided in the NRP RGS case file.

  4. The initial determination of the type of case may be changed by the Area depending on the issues selected on the return or the availability of examiners in locations that may be trained and available to examine NRP returns.

4.22.3.2.3.4.1  (10-01-2011)
Tax Compliance Officer

  1. The classifier will identify a return for assignment to a Tax Compliance Officer if it does not have a Schedule C, Schedule F, or Schedule E Page 2 (flow-through returns). These returns will generally be Activity Codes 270 through 273 although there may be some Schedule C or F returns included in codes 270 and 271 that will be identified for a Revenue Agent.

4.22.3.2.3.4.2  (10-01-2011)
Revenue Agent

  1. The classifier will identify a return for assignment to a Revenue Agent if it contains a Schedule C, Schedule F, or Schedule E Page 2 (flow-through returns). These returns will generally be Activity Codes 274 through 281.

  2. The return may also be designated for a Revenue Agent if the overall issues are determined too complex for a Tax Compliance Officer, or if an Indirect Method is indicated.

4.22.3.3  (10-01-2011)
NRP Classification of Form 1120S Returns

  1. The information in this section applies to the classification of NRP Form 1120S Corporation tax returns.

4.22.3.3.1  (10-01-2011)
Criteria for Classifying 1120S Forms and Schedules

  1. The following instructions apply to classifying NRP selected Form 1120S and attached forms and schedules. These are the Source Code 80 returns. These instructions do not apply to any flow-through returns (primarily Forms 1040) that may be associated with the Form 1120S return in classification (Source Code 91).

  2. See Training Catalog Number 11765, NRP Module C Form 1120S Classification Training, for additional information.

4.22.3.3.2  (10-01-2011)
Completion of NRP 1120S Classification Checksheet

  1. Each case file will include an NRP S Corporation (Form 1120S) Classification Checksheet (Form 13612), and can be found in the Forms/Pubs/Products Repository on the IRWeb http://irweb.irs.gov.

  2. The NRP 1120S Classification Checksheet will be completed using a computer. Specific instructions for the automated NRP 1120S Classification Checksheet are provided during training. The classification checksheet data will be accumulated for analysis and a print of the completed checksheet will be included in the case files prior to sending them to the Area PSPs. The checksheet data will be used to populate the classified items in RGS prior to the returns being sent to the field. The RGS case file will also include a copy of the classification checksheet for reference.

  3. Return identifying information (EIN, Name, Tax Period, and Control Number) will be populated on the NRP 1120S Classification Checksheet during the automated classification process. Classifiers will enter their SEID and date at the top left of the NRP Classification Checksheet. If the classified return is reviewed, the reviewer will enter their SEID and date of the review.

  4. The NRP 1120S Classification Checksheet was designed using the Standard Audit Index Number (SAIN) codes as its classification issue numbers. All classified issues will be identified on the checksheet with an "X" mark to the left of the SAIN number. There is no limit to the number of issues that may be selected.

  5. Any issues that are highlighted (light orange color) on the classification checksheet are given significant consideration by the classifier. See IRM 4.22.3.3.6

  6. All Large, Unusual and Questionable (LUQ) issues will be classified for examination. In considering whether an issue is LUQ, the classifier will judge whether there is a high probability, based on the classifier’s knowledge and experience, that the item is correct. If in doubt, the classifier will classify the item.

  7. For each classified item, the classifier will enter the amount found on the return related to the classified item and enter that amount in the "Per Return" field on the classification checksheet.

  8. Classifiers should make entries in the "Comments" column or "Remarks" section to explain why an item is classified or to provide additional information for the examiner. They may make reference to specific case building items to lead the examiner directly to the classified issue.

  9. If a classifier identifies an issue not listed on the NRP 1120S Classification Checksheet, it should be entered with specific information in the "Other Issues" section on page 5 as item 801 or 802. The Other Issues section should be used to classify other flow-through or related returns such as partnerships, trusts, etc.

4.22.3.3.3  (10-01-2011)
Classification Results and Type of Audit

  1. All Form 1120S returns will be classified according to the guidelines in this manual and all returns will be selected for face to face examination. These returns will be examined by revenue agents in SB/SE or LB&I.

4.22.3.3.4  (10-01-2011)
Specific Issue Guidelines

  1. Below are specific issue guidelines (not all-inclusive) for identifying potential non-compliance issues. Entries should be made in the Comments and Remarks sections of the NRP 1120S Classification Checksheet to clarify why the issue was classified and to provide additional guidance for the examiner.

4.22.3.3.4.1  (10-01-2011)
Introduction to S Corporation Audit Issues

  1. Classifiers will scrutinize the S Corporation return both as to line items and the return as a whole to identify and select issues with NRP examination potential. When classifying an S corporation, it has virtually all of the same issues as a C corporation. C corporation rules apply unless their result is inconsistent with treating S corporations as a pass-through entity.

4.22.3.3.4.2  (10-01-2011)
Classification of the Balance Sheet and Schedule M

  1. Classification of the S Corporation return will include the balance sheet (Schedule L) and Schedule M items. Substantial change in assets, loans to or from shareholders, accounts payable, treasury stock, capital stock, or retained earnings would indicate an examination of these items may be warranted. In addition, substantial changes in accruals and decreases in assets which are not accounted for on Schedule D of the return may be identified from an inspection of the balance sheet.

4.22.3.3.4.3  (10-01-2011)
Large, Unusual and Questionable (LUQ) Items

  1. All large, unusual, or questionable (LUQ) items on the return will be classified for examination. (IRM 4.10.2.3.1 and Exhibit 4.8.3-1) LUQ items include income, deductions, balance sheet, Schedule M items, and credit items. LUQs are items that appear on the return, which if left unexplained, might raise doubt or cause confusion to a reviewer of the closed examination.

  2. Consideration must be given to the filing and examination potential of all returns required to be filed by the taxpayer, including those entities in the taxpayers sphere of influence and responsibility. This also includes whether appropriate steps were taken to ensure compliance when related tax returns may be affected by any changes to the selected return.

4.22.3.3.5  (10-01-2011)
Mandatory Items to be Classified

  1. The following instructions apply in identifying and selecting issues that are always classified on NRP Form 1120S tax returns.

4.22.3.3.5.1  (10-01-2011)
Income Section

  1. Classifiers will classify every line item in the "Income" section of the classification checksheet where a dollar figure is shown on the Form 1120S. If the classifier questions an item in the Income section where there is no dollar entry on the return, they will provide an explanation in the "Comments" column.

  2. Classifiers will also select other income items that are present on the Schedule K if there are dollar amounts on these line items. Interest, Ordinary Dividends, and Qualified Dividends will be classified if there is nothing in the file to verify their correctness (IRP transcript).

  3. If Other Income (Loss) is selected, the classifier will review the individual line items on any schedule attached to the return to determine if one or more of the items meets the LUQ criteria.

4.22.3.3.5.2  (10-01-2011)
Schedule A – Cost of Goods Sold Section

  1. If Cost of Goods Sold (COGS) is claimed on the return, the classifier must classify at least one item in the COGS section. If the taxpayer has not completed the Schedule A but has entered a figure on the face of the return, this issue will be classified.

  2. If a dollar figure is found in Purchases, Cost of Labor, or Inventory (Ending),these issues will always be classified. The classifier will classify the remaining issues on Schedule A [Inventory (Beginning), Additional Section 263A Costs, and Other Costs] using LUQ criteria.

4.22.3.3.5.3  (10-01-2011)
Items Affecting Shareholder Basis Section

  1. Total Property Distributions will always be classified even if this return line item is blank, includes a "0" or includes any dollar amount. This issue is already marked with a "star" on the classification sheet as a reminder to the classifier and agent that this issue is always classified.

4.22.3.3.5.4  (10-01-2011)
Schedule K – Other Section

  1. Total Dividend Distributions from Earnings and Profit (E & P) will always be classified even if this return line item is blank, includes a "0" or includes any dollar amount. This issue is already marked with a "star" on the classification sheet as a reminder to the classifier and agent that this issue is always classified.

4.22.3.3.5.5  (10-01-2011)
Schedule L – Balance Sheet Section

  1. Other Current Liabilities will be classified if there is any entry on this line item.

  2. Other Liabilities will be classified if there is any entry on this line item.

4.22.3.3.6  (10-01-2011)
Highlighted Issues

  1. The issues highlighted on the NRP 1120S Classification Checksheet are referenced to Form 1120S Technical Training, Lesson 8, titled "Pre-Audit/Classification Issues." These potential issues were identified by IRS Technical Advisors as having a high probability for error. This training material is available to the NRP 1120S classifiers and can be found at http://abusiveshelter.web.irs.gov/S-Corp/S-Corps.htm. The highlighted issues are:

    1. Cancellation of Debt Income

    2. Compensation of Officers

    3. Interest

    4. Fringe Benefits

    5. Excessive Net Passive Income Tax

    6. Tax From Schedule D (Built-In Gains)

    7. Additional Taxes - LIFO Reserve Recapture Tax (IRC Section 1363(d)

    8. Section 179 Expense Deduction

    9. Charitable Contributions

    10. Total Property Distribution

    11. Non-Cash Distribution

    12. Disproportionate Distributions

    13. Total Dividend Distributions from E&P

    14. Buildings and Other Depreciable Assets

    15. Accumulated Depreciation

    16. Related Party Accruals

    17. Loans From Shareholders

    18. Reconciliation

    19. Final Return

    20. Potentially Abusive Schemes

    21. Invalid Shareholders

    22. Reconcile K-1’s to Schedule K

    23. Losses and Deductions Claimed in Excess of Stock Debt Basis

    24. Passive Activity Losses and Material Participation

    25. Corporate Level Limits

Exhibit 4.22.3-1 
Correspondence Examination Issues

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Exhibit 4.22.3-2 
Correspondence Examination Issues

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Exhibit 4.22.3-3 
Correspondence Examination Issues

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