4.2.6 Examination of Employee Returns

Manual Transmittal

August 09, 2019

Purpose

(1) This transmits revised IRM 4.2.6, General Examining Procedures, Examination of Employee Returns.

Material Changes

(1) Significant changes to this IRM are reflected in the table below:

IRM Reference Description of Change
IRM 4.2.6.1 through IRM 4.2.6.1.5 Added content to provide background information, legal authorities that govern the actions covered in this IRM, responsibilities, acronyms, and related resources available to assist examiners when conducting employee examinations.
IRM 4.2.6.3.1 Added clarification for the examiner to review TXMOD when Form 5546 is not available.
IRM 4.2.6.3.8 Revised guidance when a joint investigation is initiated with Criminal Investigation (CI) and removed reference to obsoleted Form 2677.
IRM 4.2.6.3.10 Revised the title and clarified guidance when an employee resigns.
IRM 4.2.6.7 Revised guidance regarding where to send closed cases.
Throughout IRM 4.2.6 Minor editorial changes have been made throughout this IRM. Website addresses, legal references, and IRM references were reviewed and updated as necessary.

Effect on Other Documents

This revision supersedes IRM 4.2.6 dated March 4, 2013.

Audience

Small Business/Self-Employed (SB/SE), Large Business and International (LB&I), and Tax Exempt and Government Entities (TE/GE), examination personnel.

Effective Date

(08-09-2019)

Maha H. Williams
Director, Examination–Field and Campus Policy, SE:S:E:HQ:EFCP
Small Business/Self-Employed

Program Scope and Objectives

  1. Purpose. This IRM provides technical guidance regarding the examination of employee tax returns.

  2. Audience. This guidance applies to all Service employees who are working on cases involving the examination of an employee tax return.

  3. Policy Owner. The Director, Examination - Field and Campus Policy, who is under the Director, Headquarters Examination.

  4. Program Owner. Field Exam General Processes (FEGP), which is under the Director, Examination - Field and Campus Policy.

  5. Contact Information. To recommend changes or make any other suggestions related to this IRM section, see IRM 1.11.6.6, Providing Feedback About an IRM Section - Outside of Clearance.

Background

  1. This IRM provides procedures on the examination of employee returns and information regarding the employee’s responsibility for timely filing, accurately reporting and paying of all taxes.

Authority

  1. The following provide the authority for topics referenced within this IRM:

    • IRS Restructuring and Reform Act of 1998 (RRA) sections 1203(b)(8) and 1203(b)(9),

    • 5 CFR 3101.106(b)(2), and

    • IRM 1.2.1.5.7, Policy Statement 4-9, Highest integrity expected.

Responsibilities

  1. The Director, Headquarters Examination, is the executive responsible for providing policy and guidance for SB/SE Examination employees and ensuring consistent application of policy, procedures and tax law to effect tax administration while protecting taxpayers’ rights. See IRM 1.1.16.3.5, Headquarters Examination, for additional information.

  2. The Director, Examination - Field and Campus Policy, reports to the Director, Headquarters Examination, and is responsible for the delivery of policy and guidance that impacts the examination process. See IRM 1.1.16.3.5.1, Field and Campus Policy, for additional information.

  3. Field Exam General Processes (FEGP), which is under the Director, Examination - Field and Campus Policy, is the group responsible for providing policy and procedural guidance on standard examination processes to field employees. See IRM 1.1.16.3.5.1.1, Field Exam General Processes, for additional information.

  4. All employees are responsible for timely filing, accurately reporting and paying all taxes.

  5. Income tax examiners and their managers should thoroughly acquaint themselves with the information contained in this IRM, as well as other resources, such as those listed in IRM 4.2.6.1.5, Related Resources, below.

Acronyms

  1. The following table lists and defines acronyms commonly used throughout this IRM:

    Acronyms Definition
    CCP Centralized Case Processing
    CFOL Computer Files On Line
    ERCS Examination Returns Control System
    IRP Information Return Processing
    LR/ER Labor/Employee Relations
    SC Source Code
    SSN Social Security Number
    TSC Technical Services Code
    TIGTA Treasury Inspector General for Tax Administration
    TS Technical Services

Related Resources

  1. The following IRMs provide additional information:

    • IRM 1.2.13.1.7, Policy Statement 4-9, Highest Integrity Expected

    • IRM 1.2.43.34, Delegation Order 4-40(formerly DO-244, Rev. 1), IRS Employee Returns Selected for Examination

    • IRM 4.1.1.6.7, Employee Audits

    • IRM 4.8.4, Mandatory Review

    • IRM 4.10.2, Pre-Contact Responsibilities

    • IRM 4.10.5, Required Filing Checks

    • IRM 4.13, Audit Reconsideration

    • IRM 25.1, Fraud Handbook

  2. Helpful information can be found on the following website:

    • http://mysbse.web.irs.gov/exam/tip/emplaudit/default.aspx

    • Baltimore Technical Services

Employee Tax Compliance

  1. As the administrators of our nation's tax system, our dedication to the highest standards of ethical behavior and conduct promotes the public trust in our honesty, fairness and efficiency. Therefore, IRS employees are expected to fully comply with all tax laws by accurately reporting and timely filing their federal, state, and local tax returns and fully paying their taxes when due. This includes paying the proper amount of tax (e.g., estimated tax payments and withholding) as income is earned during the tax year. RRA 98 sections 1203(b)(8) and (b)(9) provide for the removal of IRS employees who willfully fail to file any return of tax required under the Internal Revenue Code of 1986 on or before the date prescribed therefore, or who willfully understate federal tax liability respectively. To this end, the IRS has established a comprehensive employee tax compliance program. Employees' accounts will be subjected to examination, underreporter, and annual delinquency check procedures.

  2. Each area has an employee audit coordinator. The employeeaudit coordinator is located in the area Planning and Special Programs (PSP) office. A list of coordinators may be found at the Employee Audit Contacts menu on the following website: http://mysbse.web.irs.gov/exam/tip/emplaudit/contacts/default.aspx.

Examination of Employee Returns

  1. IRM 1.2.13.1.7, Policy Statement 4-9, Highest Integrity Expected, provides that standard IRS procedures relating to examinations, proposed changes, appeal rights, etc., will apply to IRS employees to the same extent they apply to all other taxpayers.

  2. Examination of employee returns are generally in six categories:

    • New employee examinations

    • Current employees who have not previously held an auditable position and who are newly hired into an auditable position

    • Regularly classified employee examinations (returns that are classified under regular circumstances, such as DIF, but happen to be an employee)

    • Executive selections

    • Treasury mandated audits

    • Special projects to address identified employee compliance problems

Identification of Employee Returns

  1. Examiners should review Form 5546, Examination Return Charge-Out Sheet, on every case file to determine if it reflects the words "Employee Return." This designation can be found about one third of the way down from the top of the Form 5546. If Form 5546 is not in the case file, the examiner should secure and review IMFOLI to check for an IRS employee indicator. See Exhibit 2.3.151-12, Command Code IMFOL Output Display — Index, for codes and additional information.

  2. The examiner should also check for a project and/or tracking code. The following project and tracking codes apply to employee audits:

    • Project code 0206 – Executive selections

    • Project code 0207 – Treasury mandates

    • Project code 0389 – New employees

    • Project code 0913 – Employee audit transferred from campus

    • Project code 1030 – Criminal Investigation (CI) pre-hires

    • Tracking code 7569 – Employee audits

      Note:

      Tracking code 7569 is generally used to track an employee audit that originated in a source code (SC) other than SC 46, Employee Returns (generally SC 46 is used for the primary tax year for an employee audit; SC 40 is used for prior and subsequent tax year(s); and SC 50 is used for related returns). An example of other possible source codes are DIF (SC 20), Compliance Initiative Project (CIP) (SC 62), NRP (SC 80), etc.

  3. When special projects are initiated to address identified employee noncompliance, they may be assigned a unique project and or tracking code.

  4. If a return has not been pre-identified as an employee return and it is found to be an employee return after further inspection/examination, the examiner must notify their group manager as soon as possible. The group manager will determine whether the examiner may proceed with examining the return or whether it should be reassigned. The words "employee return" should be written at the top of the Form 5546 or the IMFOLI (when no Form 5546 is in the case file). The examiner must document actions taken on Form 9984, Examining Officer's Activity Record.

  5. Conversely, if a return has been pre-identified as an employee audit and the individual is no longer employed with IRS, follow the procedures in IRM 4.2.6.3.10.

Examiner Impartiality

  1. Examiners must ensure impartiality and independence when examining an employee return. If examiners have any reason to believe that their impartiality and independence may be questioned, they should discuss the matter with their immediate supervisor for reassignment consideration.

  2. The impartial and independent character of examinations of IRS employees and officials must be ensured. See IRM 4.1.1.6.7, Employee Audits, for guidelines on assignment of employee returns for examination.

Assignment of Employee Returns

  1. Employee audits are high priority cases and should be assigned within 10 business days of arrival into the group.

Examiner Travel to the Employee Location

  1. When an examiner is assigned an employee return for examination and the employee is located in another post-of-duty, the examiner is authorized to travel to the employee's business, residence, or other location where the books and records are maintained. All travel costs will be borne by the examining area.

Conducting the Employee Examination

  1. An examination of an employee generally should be worked as a normal examination. The employee under examination should not be given preferential treatment nor should the employee be held to a higher standard than any other taxpayer under examination.

  2. Normal pre-contact responsibilities apply to an employee audit. The examiner should use current risk based decision tools in any decision to adjust the scope of the examination. See IRM 4.10.2, Pre-Contact Responsibilities.

  3. Normal required filing checks apply to an employee audit. See IRM 4.10.5, Required Filing Checks.

  4. Employee audits are very sensitive and require certain modifications to the examination process. The following modifications must be made:

    1. The examiner should use the normal and appropriate initial appointment letter to begin the examination. See IRM 4.2.6.5 for employee interview procedures.

    2. The examiner should include Form 8111, Employee Notification Regarding Union Representation, with the initial contact letter provided to bargaining unit employees and attempt to secure a signed copy before the initial interview takes place. The Form 8111 is used to secure the employee's acknowledgement that he or she has been advised of his or her right to union representation during the interview pursuant to 5 USC 7114(a)(2)(B). If the employee does not provide a signed Form 8111, the examiner will notate "Discussed and Solicited a Signed Form 8111—Employee Did Not Provide Signed Form 8111" on Form 8111 and proceed with the interview. See IRM 4.2.6.5(2)(a) for additional information.

    3. Employee tax examinations are to be kept in an orange file folder at all times. See IRM 4.1.5.2.5, Use of Colored Folders.

  5. The employee audit website is located at http://mysbse.web.irs.gov/exam/tip/emplaudit/default.aspx.

Examination of Spouse’s Separate Return

  1. The return of an employee’s spouse who has filed separately should be inspected as part of the required filing checks to determine if it should be examined. A copy, RTVUE, or CDE print of the spouse’s return must be included with the employee’s return if it is not examined. See IRM 4.8.4.2.4.3, Key Points for Reviews.

  2. If the spouse’s return is examined, each Form 3198, Special Handling Notice for Examination Case Processing, should be cross referenced with the taxpayer identification number (TIN) of the related return.

Violations of the Code of Conduct

  1. If facts are disclosed during the examination that indicate an employee may have engaged in any activity in violation of the rules of employee conduct, the examiner should refer to Document 12011, Internal Revenue Service Ethics Handbook, and consult with his or her manager.

Fraud

  1. Current civil and criminal fraud procedures will be followed, where applicable. See IRM 25.1, Fraud Handbook. Certain fraud technical advisors (FTA) have been designated to assist with employee examinations. The FTA should be identified in the packet that accompanied the case file. If no information is available, contact the manager of FTA Group 5 or the area's employee audit coordinator.

  2. If a joint investigation is initiated with Criminal Investigation on an employee audit, the examiner should immediately contact the Field Exam General Processes analyst at: Employee Audits - Contacts.

Contacts with Labor/Employee Relations

  1. Labor/employee relations (LR/ER) specialists will occasionally request an update on the audit status. Their request should be directed as follows:

    1. If the case was recently closed from the group and sent for mandatory review, the LR/ER specialist should contact the Baltimore Technical Services group manager.

    2. If the case is assigned to an examination group, the LR/ER specialist should contact the group manager.

Individual No Longer Employed with IRS

  1. If the employee under examination resigns, the examiner must take the following actions:

    1. Notify the group manager and area employee audit coordinator of the resignation and document this activity on the Form 9984, Examining Officer's Activity Record.

      Note:

      The employee audit coordinator will have the IRS Employee Indicator on command code AMDISA removed.

    2. Discuss the scope of the examination with the group manager. Based on the facts and circumstances of the case, the examination scope may need to be concluded, limited, or continued as planned. See IRM 4.10.2, Pre-Contact Responsibilities.

    3. Remove the employee audit project code and/or tracking code, if present, because the case is no longer subject to mandatory review, by completing Form 5348 and providing it to the area AIMS analyst. The case is no longer subject to mandatory review.

    4. Check the "Other" box under the Special Features section of the Form 3198 and notate the case is no longer an employee audit.

    5. Remove the case from the orange folder.

    6. Cross through the words "employee return" on the Form 5546 or on IMFOLI (when no Form 5546 is in the case file) and note the individual is no longer employed with IRS.

  2. The group manager should decide whether to retain the case and work it or survey it using survey procedures. See IRM 4.2.6.6 below for additional detail. The case will no longer be considered high priority.

New Employee Examinations

  1. Current employees newly hired into auditable positions and new employees in auditable positions must undergo employee tax return reviews or examinations or both.

  2. The employee audit coordinator establishes controls on employee examinations and builds the case file.

  3. The package sent to the group should contain the following items:

    • Return(s) (original, copy, RTVUE, or CDE print) and

    • CFOL reports of account history for the open years and information return processing (IRP) transcripts.

  4. Employee returns will be examined in the same manner as all individual income tax returns, which include conducting minimum income probes and required filing checks.

  5. If the primary reason for the examination of a new employee’s return is consideration for employment and the individual is no longer employed by IRS or is no longer being considered for employment, the examiner must discuss the scope of this case with his or her group manager. See IRM 4.2.6.3.10.

Employee Interview Procedures

  1. The initial interview in an employee tax audit has increased significance, as the outcome of the examination may initiate a conduct investigation. The examiner’s interview questions should adequately probe the employee’s role in preparation of the return, participation in any businesses, investments, income producing activities, and the employee’s role in identifying expenses or adjustments to income.

  2. The examiner’s initial interview of an employee may be considered an investigatory interview, and a bargaining unit employee may elect to have union representation.

    1. The examiner should provide the employee with a copy of Form 8111, Employee Notification Regarding Union Representation, with the initial contact letter, discuss Form 8111 before conducting the initial interview, and request the employee sign Form 8111 to acknowledge notification of his or her contractual rights. If the employee does not provide a signed Form 8111, the examiner will notate "Discussed and Solicited a Signed Form 8111—Employee Did Not Provide Signed Form 8111" on Form 8111 and proceed with the interview. The interview should not be delayed in order to secure a signed copy of Form 8111.

    2. The examination should not be unreasonably delayed to secure union representation.

    3. An IRS employee is barred from appearing on behalf of any taxpayer as a representative before any federal, state, or local governmental agency, in an action involving a tax matter except on written authorization of the Commissioner of Internal Revenue, (5 CFR 3101.106(b)(2)). A union representative may be present and represent the employee in a conduct issue.

  3. Employee Attendance at the Audit: IRC 7521(c) generally prohibits IRS from requiring a taxpayer to accompany the taxpayer's recognized representative to an audit in the absence of an administrative summons. However, IRC 7521(d) provides that IRC 7521(c) shall not apply to investigations relating to the integrity of any officer or employee of the IRS. Since an audit of an employee relates to the integrity of the employee and may result in a disciplinary or adverse action against the employee, the employee's recognized representative may not attend the audit in lieu of the employee, although the recognized representative may accompany the employee to the audit.

    Note:

    A recognized representative is any attorney, certified public accountant, enrolled agent, enrolled actuary, or any other person permitted to represent that taxpayer before the IRS who is not disbarred or suspended from practice before the IRS and who has a written power of attorney executed by the taxpayer.

  4. An employee will be granted administrative leave to attend a tax audit or a discussion of the employee’s own tax affairs.

  5. An employee will not be granted administrative leave to prepare for an examination.

Survey of Employee Returns

  1. Survey procedures are applicable only to new employee examinations and regularly classified returns. Treasury mandates (TIGTA referrals) and executive selections cases cannot be surveyed.

  2. Once an IRS employee's return has been selected for examination and assigned to a group, it can only be surveyed with written approval. This survey action must include a description of any documents and or other information used to draw this conclusion. Surveys are subject to mandatory review. See IRM 1.2.43.34, Delegation Order 4-40 (formerly DO-244, Rev. 1), IRS Employees’ Returns Selected for Examination, for the appropriate approving official.

  3. When an examiner believes that an examination of an employee's return would result in no material change in tax liability, he or she may apply survey after assignment procedures. The examiner will prepare a Form 1900, Income Tax Survey After Assignment, stating the reasons for the survey action. If the examiner's group manager concurs, he or she will approve the case and forward it to the Territory Manager for his or her consideration and final approval on Form 1900. Refer to IRM 1.2.43.34, Delegation Order 4-40 (formerly DO-244, Rev. 1), for the appropriate approving official.

  4. If the group manager decides an employee's return should be surveyed before assignment, the group manager should follow the survey after assignment procedures as outlined in the preceding paragraph. The group manager should forward the case file to TS after securing the territory manager's approval.

  5. Check the "Employee Audit" box on Form 3198, Special Handling Notice for Examination Case Processing, in the "Forward to Technical Service" section, when closing the case.

Closing an Employee Examination

  1. All employee audits are mandatory review, thus the "Employee Audits" box in the "Forward to Technical Services" section of Form 3198, Special Handling Notice for Examination Case Processing, must always be checked regardless of the type of closure (this includes surveys).

  2. All employee audit returns are subject to mandatory review and must be closed directly to the Employee Audit Reviewer in Baltimore Technical Services. The case file must be placed in a "Confidential" envelope. The ERCS Technical Services Code (TSC) and RGS group number must be updated upon closure as follows:

    • ERCS - Technical Services Code (TSC): 109

    • RGS:

      Area/NRP RGS Group
      Area 1 14
      Area 2 24
      Area 3 34
      Area 4 44
      Area 5 54
      Area 6 64
      Area 7 74
      NRP 9E
  3. In the case of a joint return, identify the name and social security number (SSN) of the IRS employee on Form 3198 by checking the "other" block in the "Forward to Technical Services" section and notate the name and SSN of the employee on the lines provided.

  4. Baltimore Technical Services will close the case to the appropriate Centralized Case Processing (CCP) office.

  5. Once the case is closed from Baltimore Technical Services, CCP will forward the required employee audit information in the case file to the requesting official such as Labor/Employee Relations, Treasury Inspector General for Tax Administration (TIGTA), or IRS Personnel Security.

Audit Reconsiderations

  1. An employee may avail themselves of the audit reconsideration process. Refer to IRM 4.13, Audit Reconsiderations, for information concerning the audit reconsideration process and procedures.

  2. Employee audit reconsideration cases that are selected will be sent to the appropriate area PSP office for assignment and control. The case should be returned to the group and examiner that originally worked the case. Employee audit reconsideration cases are high priority cases. They are given the same priority status as employee audit cases.

  3. The purpose of the audit reconsideration is to examine information that was not previously considered. The examiner should review IRM 4.13.4.3, Area Office (AO) Examination Group Procedures, for guidance and procedures for examining and closing an audit reconsideration case.