4.22.3 Classification of NRP Returns

Manual Transmittal

December 29, 2017

Purpose

(1) This transmits revised IRM 4.22.3, National Research Program (NRP), Classification of NRP Returns.

Material Changes

(1) The IRM was edited to accommodate the internal control information for the NRP. As part of this effort, the content was rearranged for readability and clarity

(2) In addition, the IRM was reviewed to update references and other minor editorial changes.

Effect on Other Documents

This supersedes IRM 4.22.3 dated December 27, 2011.

Audience

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

Effective Date

(12-29-2017)

Erik Ogilvie
Chief, National Research Program
Knowledge, Development and Application
Research, Applied Analytics and Statistics

Program Scope and Objectives

  1. Purpose. This IRM contains information related to the classification of NRP key case tax returns. The types of returns applicable to these cases include examinations of:

    • Form 1040, Individual Income Tax - See IRM 4.22.6

    • Form 1120S, Sub-Chapter S Tax- See IRM 4.22.7

    • Form 1120, Corporate Income Tax See IRM 4.22.11 , IRM 4.22.12

    • Form 941, Employment Tax See IRM 4.22.10

    • Form 720, Fuel Excise Tax - See IRM 4.22.13

  2. Audience. This information applies to IRS employees who participate in an NRP study including:

    • Classifiers

    • Examiners

    • Group managers

    • Reviewers

    • NRP staff

  3. Director, Knowledge Development and Application, Research, Applied Analytics and Statistics (RAAS), is the policy owner.

  4. NRP is the program office responsible for the oversight of the NRP studies.

  5. For information about the National Research Program, visit the NRP website at: http://nrp.web.irs.gov.

Background

  1. Each return in the NRP sample is randomly selected and weighted to represent hundreds or thousands of similar returns in the general filing population. Because of the statistical significance of each return in the sample, all returns should be carefully scrutinized for indications of noncompliance.

  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.

Responsibilities

  1. Director, Research Applied Analytics and Statistics (RAAS)

  2. Director, Data Management Division (DMD)

  3. Chief, National Research Program (NRP)

  4. Compliance employees under:

    • Small Business and Self Employed (SB/SE)

    • Large Business and International (LB&I)

    • Tax Exempt/Government Entities (TE/GE)

Terms and Acronyms

  1. Following is a list of the defined terms applicable to classification:

    1. Case building: The process of collecting information for classification and adding information to the case file, from both IRS and non-IRS sources. Use of this information during the classification process will help identify or eliminate potential issues and provide the examiner with the maximum amount of information to guide the examination activity. For specific case building items related to each study, see IRM 4.22.2, NRP Case Building.

    2. Classification: The process of identifying cases and issues for examination.

    3. Classified Issue List: A list of the issues identified during classification and included in each electronic case file. Each issue includes the IMF/SAIN code, issue name, per return amount, form/schedule, line number, and any issue-related comments entered by the classifier. Any case related comments entered by the classifier will also be included at the bottom of the document.

    4. Information Reporting Program (IRP): Matching program that compares income reported by third party entities to the amount reported by the taxpayer on the tax return.

    5. Key case returns: Returns identified by NRP through a random selection process. Key case returns use AIMS Source Code 80.

    6. Report Generation Software: A comprehensive program used throughout the examination process to perform a variety of audit and review tasks. In addition to computing tax, penalties, and interest on the examination report, RGS generates correspondence, work papers, and case closing documents.

  2. Following is a list of acronyms relating to classification:

    1. AIMS - Audit Information Management System

    2. CDE - Certified Data Environment

    3. CRN - Credit Reference Number

    4. EIC - Earned Income Credit

    5. FAX - Facsimile

    6. IDRS - Integrated Data Retrieval System

    7. IMF- Individual Master File

    8. IRP - Information Reporting Program

    9. IRPTR - Information Returns Processing Transcript Requests

    10. LB&I - Large Business and International Division

    11. LUQ - Large, Unusual and Questionable

    12. NRP - National Research Program

    13. PSP - Planning and Special Programs

    14. RA - Revenue Agent

    15. RGS - Report Generation Software

    16. SB/SE - Small Business and Self Employed Division

    17. SSN - Social Security Number

    18. TCO - Tax Compliance Officer

    19. TE/GE - Tax Exempt and Government Entities Division

Related Resources

  1. IRM 4.22.1, National Research Program Overview

  2. IRM 4.22.2, Case Building

  3. IRM 2.3, IDRS Terminal Responses, for command code information

  4. IRM 4.10.2, Pre-Contact Analysis

General NRP Classification Requirements and Standards

  1. 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. Collectability Indicator will not be a consideration to accept a return as filed.

  2. Classifiers will not classify returns they may examine. If they select a return to classify that they may be required to examine, they will immediately notify their NRP Coordinator or the classification coordinator so the case may be reassigned.

  3. 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 schedules, elections, and any other 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.

  4. Classifiers will compare the return to the transcripts in the case building information. This will identify if 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.

  5. Generally, all Large, Unusual and Questionable (LUQ) issues (defined in IRM 4.22.3.1.3), 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.

  6. When warranted, the classifier will identify 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.

  7. Many tax return amounts can be corroborated using case building material. If the case building material matches the items reported on the tax return, generally the item will not be classified.

  8. Classifiers may use any research tools, reference materials, or job aids available to them.

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.

Classification Review

  1. All classified NRP returns are available for review by a trained reviewer. For each classified return, the NRP reviewer must perform a full review, a partial review, or accept the classification results without review.

  2. The Area NRP Coordinators will serve as the classification reviewers. Initially, all classified NRP returns will be fully reviewed. 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.

  3. 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 percent sample of returns classified during the classification session. Quality and consistency of classification will be stressed.

  4. 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 during classification.

  5. 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.

  6. Coordinators who return to the field will not examine any cases they reviewed or error checked during any classification session. The coordinator’s review status can be verified by reviewing the Classified Issue List.

Missing Forms, Schedules or Line Items

  1. The classifier must determine if the return is complete and contains all necessary forms and schedules. Any forms or schedules identified by the classifier as missing should be classified on the appropriate line item. 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.

NRP Form 1040 Classification Return System

  1. The NRP Classification Return system is accessed through a secure web site.

  2. There are three different NRP 1040 Classification Return forms that will display depending on the type of return filed:

    • Form 1040

    • Form 1040A

    • Form 1040EZ

  3. The NRP Form 1040 Classification Return form is completed and reviewed electronically. Specific instructions for accessing and using the automated NRP 1040 Classification System are provided to classifiers and reviewers during training.

  4. 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.

  5. 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 the date reviewed will also be captured.

  6. The Classification Return form will display the dollar amounts as shown on the tax return. Every item with an amount other than zero must be considered and a classification determination of Verified, Classified or Not LUQ must be made.

  7. After reviewing the classified issues on the return, the classifier will select a classification result of:

    1. Accepted as Filed,

    2. Accepted with Adjustments,

    3. Correspondence,

    4. TCO, or

    5. RA

  8. When necessary, classifiers include specific comments regarding why the issue was classified.

  9. 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).

    1. "P" refers to the first (primary) Social Security Number listed on the return and

    2. "S" refers to the second Social Security Number on the return.

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.

Earned Income Credit
  1. The examination and documentation of the Earned Income Credit is an integral part of an NRP Form 1040 study.

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

  3. To classify EIC, select one or more of the following issues:

    • Exemptions: Dependent Children Who Lived with Taxpayer

    • Exemptions: Dependent Children Who Did Not Live With Taxpayer

    • 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 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

  5. Taxpayers claiming EIC with qualifying children must be examined by a RA or TCO.

  6. Taxpayers claiming EIC with no children may be examined by the Campus Correspondence Unit.

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 income items will always be classified even when verified by IRP.

  4. 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. For additional guidance, see IRM 4.22.3.3.4.12.

  5. 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.

  6. In using the IRP documents to verify amounts reported on the tax return, the classifier may disregard a specific mismatch if it is below the tolerance set by NRP or appears to be a rounding discrepancy.

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

  8. The classifier will consider indications on the return that the taxpayer(s) had insufficient income to support their standard of living. For example:

    1. If gross itemized deductions exceed Adjusted Gross Income, classify "income."

    2. If the classifier questions whether the taxpayer(s) has enough income to sustain their apparent lifestyle, classify the "Other Income" issue and provide notes in the "Comments" box.

    3. The classifier may recommend "Indirect Method" if they believe a more thorough examination of income is warranted.

Large, Unusual or Questionable (LUQ) Criteria
  1. All LUQ items on the return will be classified for examination. The LUQ criteria are applied to any line items that are not required to be classified. 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 consider when identifying LUQs are:

    1. The comparative size of the item,

    2. The absolute size of the item,

    3. The inherent character of the item,

    4. Evidence of intent to mislead, etc.

Filing Status – Head of Household
  1. The Head of Household filing status will always be classified on all NRP returns.

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

Foreign Tax Credit
  1. This issue is always classified if an IRPTR discrepancy exists.

  2. If the issue is classified and meets the established referral criteria as defined in IRM 4.60.6, the classifier must state in the “Comments” box that there is a Mandatory International Referral.

Schedule A - Itemized Deductions
  1. Schedule A (Itemized Deductions) items above a pre-determined NRP threshold will be classified. This is the most significant exception to applying LUQ criteria for NRP. Small adjustments to itemized deduction amounts are extremely significant for NRP research purposes because of the great number of taxpayers that itemize their deductions.

  2. Items on Schedule A that can be corroborated by case building information do not need to be classified. For example, Home Mortgage Interest and Points deducted on Schedule A can be verified from Form 1098 information on the IRPTR document. Because some taxpayers may be limited in the amount of their allowable deduction, classifiers must classify this issue if it is a high dollar amount rather than accept the amount claimed because it matches the Form 1098 amount.

  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.

Employee Business Expenses – Form 2106/Form 2106-EZ
  1. Employee business expenses from Form 2106 or Form 2106-EZ are classified using a pre-determined NRP threshold. The classifier will designate whether the schedule pertains to the primary or secondary Social Security Number or both.

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 be classified even if the amounts match IRP documents.

  2. Expenses on these schedules (including Cost of Goods Sold) will generally be classified using the LUQ criteria.

  3. The classifier will designate whether the schedule pertains to the primary or secondary Social Security Number or both.

  4. 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."

  5. 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.

Schedule D – Capital Gains and Losses
  1. In general, all line items on Schedule D are classified using the LUQ criteria, including any IRP discrepancies.

  2. All identified Like-Kind Exchanges will be classified whether or not the return was filed with Form 8824 , Like-Kind Exchanges.

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 except for "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.

Schedule F – Income or Loss from Farming
  1. The following Schedule F income items will be classified regardless of their amount, even if they match IRP documents:

    • Sch F Sales of Livestock & Other Resale Items (Cash)

    • Sch F Sales of Livestock, Produce, Grains and Other Products You Raised (Cash)

    • Sch F Custom Hire (Machine Work) Income (Cash)

    • Sch F Other income (Cash)

    • Sch F Sales of Livestock, produce, grains, and other products (Accrual)

    • Sch F Custom Hire (Machine Work) Income (Accrual)

    • Sch F Other Income (Accrual)

  2. The remaining Schedule F income items will be classified unless verified by case building material. Schedule F expenses are classified using the LUQ criteria except for "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.

  3. 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.

Classification Results

  1. The NRP tax return will be completely classified prior to the determination of the classification results.

  2. After classifying the return, the classifier will indicate the overall result on the Classification Return Form based on criteria defined in the following sections.

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

Accepted as Filed
  1. The classified NRP return will be designated as "Accepted as Filed" if all the following criteria apply:

    1. The total of all classified issues is less than the total return tolerance, and

    2. There are no income items which cannot be verified by case building, and

    3. There are no non-dollar items for related party transactions, and

    4. There are no discrepancies related to IRP documents or processing errors.

  2. If there are issues for which dollar amounts are not known, (such as, Other income - standard of living, Schedule C/F - Gross Receipts, etc.), classifiers will select the return for audit.

  3. 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.

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.

Correspondence Examination
  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 classified issues are only counted as one issue for the total Correspondence issue count.

    Example:

    The classifier may select "Schedule A State and Local Income Taxes," "Schedule A Real Estate Taxes" and "Schedule A Personal Property 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 if 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 a Correspondence examination.

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.

  3. The classifier will determine whether the classified return should be assigned to a TCO or RA based on Area guidance from the NRP Coordinator. 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.

Tax Compliance Officer (TCO)
  1. Generally, the classifier will identify a return for assignment to a TCO if it does not have a Schedule C, Schedule F or Schedule E Page 2 (flow-through returns).

  2. 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 an RA.

Revenue Agent (RA)
  1. Generally, the classifier will identify a return for assignment to a RA 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 an RA if the overall issues are determined too complex for a TCO, or if an Indirect Method is indicated.

NRP Classification of Form 1120S Returns

  1. The information in this section applies to the classification of NRP Form 1120S Corporation tax returns. These are Source Code 80 returns.

  2. These instructions do not apply to any prior, subsequent or related returns (Source Code 91) that may be associated with the Form 1120S return in classification.

Completion of Form 13612, NRP 1120S Classification Checksheet

  1. Each case file will include a Form 13612, NRP S Corporation (Form 1120S) Classification Checksheet.

  2. Classifiers will complete the PDF version of Form 13612 online following the instructions provided during training.

  3. Form 13612 data will be accumulated for analysis and included in the case files prior to sending them to the Area PSPs. The 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 Form 13612 for reference.

  4. Return identifying information (EIN, Name, Tax Period, and Control Number) will be populated on the Form 13612 during the automated classification process. Classifiers will enter their SEID and date at the top left of the Form 13612. If the classified return is reviewed, the reviewer will enter their SEID and date of the review.

  5. The Form 13612 was designed using the Standard Audit Index Number (SAIN) codes as its classification issue numbers. All classified issues will be identified on the Form 13612 with an "X" mark to the left of the SAIN number. There is no limit to the number of issues that may be selected.

  6. Any issues that are in bold font or highlighted on the Form 13612 are given significant consideration by the classifier. See IRM 4.22.3.4.5

  7. All 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.

  8. 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 Form 13612.

  9. Classifiers will enter "Comments" or "Remarks" to explain why an item is classified or to provide additional information for the examiner. They may also reference the specific case building items to lead the examiner directly to the classified issue.

  10. If a classifier identifies an issue not listed on the Form 13612, 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.

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 RAs in SB/SE or LB&I.

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 Form 13612 to clarify why the issue was classified and to provide additional guidance for the examiner.

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 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.

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.

  2. 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.

  3. 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.

Large, Unusual and Questionable (LUQ) Items
  1. All large, unusual, or questionable (LUQ) items on the return will be classified for examination. 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. See Exhibit 4.22.3-1.

  2. Consider the filing and examination potential of all returns required to be filed by the taxpayer, including those entities in the taxpayer’s 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.

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.

Income Section
  1. Classifiers will classify every line item in the Income section of the Form 13612 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.

Schedule A – Cost of Goods Sold
  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.

  3. The classifier will classify the remaining issues on Schedule A [Inventory (Beginning), Additional IRC 263A Costs, and Other Costs] using LUQ criteria.

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.

  2. 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.

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 Form 13612 as a reminder to the classifier and RA that this issue is always classified.

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.

Highlighted Issues

  1. The issues highlighted on the Form 13612 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 Form 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

NRP Classification of Form 1120 Returns

  1. The NRP Form 1120 study uses an automated classification program. The program design is based on customer data needs. The program is organized by form, schedule, line number, SAIN structure and RGS/BNA data requirements, and is mapped into the existing data capture plan.

  2. In the NRP classification process, every item on the return and all attachments are considered, regardless of materiality or tax impact.

  3. The following issues are always classified for Form 1120 cases.

    • Form 4562, Depreciation

    • All Income Items including Gross Receipts

    • Like-Kind Exchanges

    • Loans To Shareholders

    • Loans From Shareholders

    • Net Operating Losses (NOLs)

    • Officer-Shareholder Compensation

    • Related Party Transactions

    • Schedule M

  4. Additional issues in the NRP 1120 automated classification process are selected based on their relationship to other items on the return and LUQ criteria.

  5. Some of the benefits of using an automated classification process include:

    1. Applying classification guidelines in an objective manner across all cases in the 1120 study

    2. Allowing data to be validated before cases are released to the field using front end data validation rather than waiting for cases to be closed

    3. Saving resources by not requiring RAs to be detailed for classification assignments

    4. Allowing for flexible classification criteria, and

    5. Using a process where all returns included in a study year can be classified in minutes after complete data has been assembled.

NRP Classification of Employment Tax Returns

  1. Due to the nature of Employment Taxes, issues for examination must be established at the Examiner level. An "issue list" will be provided as part of the Data Capture Instrument (DCI-1) and any issues that affect the entity will define the minimum scope of the examination.

  2. All issues must be included in the DCI-1 - Workpapers file.

  3. Examiners should be aware of other issues that impact the NRP Employment Tax year. Examiners must expand the scope of the NRP year examination to other issues, regardless of materiality.

  4. The following issues are classified on the DCI-1 and must be addressed on every NRP employment tax key case:

    • Form 1099 Filing Checks

    • Back-up Withholding

    • Fringe Benefits – Executive

    • Fringe Benefits – Non-executive

NRP Classification of Form 720, Fuel Excise Tax Returns

  1. All fuel abstracts are components of an NRP examination. Classified issues are fuel abstracts reported on Form 720 by the taxpayer with a liability or mark. These issues and any additional abstracts identified by the examiner during an exam will be established on the Issue Management System (IMS).

  2. All fuel abstracts are included in the Data Capture Instrument (DCI) and require examiner comment.

  3. Classified issues also include any reported (non-zero) Schedule C-Credit Reference Numbers (CRNs). These issues and any additional claims identified by the examiner during an exam will be established on the Issue Management System (IMS) according to existing examination guidelines.

  4. All Schedule C, CRN issues that are classified or added by the examiner must be included in the Data Capture Instrument (DCI) and require examiner comment.

Correspondence Examination Issues

The NRP Correspondence Examination Issue list is used by the Form 1040 NRP classifiers to determine which issues can be worked in Correspondence Examination and drives the determination of which Form 1040 NRP returns will be assigned to the Campus Compliance Operations Site for examination.

Note:

For any line item with multiple categories, one or more issues count as one for purposes of the total Correspondence issue count (identified with an asterisk*)

IRP Discrepancy Income Items (Underreported - the taxpayer reported less than IRP)

  • Wage

  • Taxable Interest

  • Ordinary Dividends

  • Qualified Dividends

  • Taxable Refunds, Credits or Offsets of State and Local Income Taxes

  • IRA Distributions

  • Pensions and Annuities

  • Unemployment Compensation

  • Social Security Benefits

  • Alaska Permanent Fund Dividend

Filing Status (other than related to EIC)

Exemptions (other than related to EIC)*

  • Exemptions - Self/Spouse

  • Dependent Children Who Lived with Taxpayer

  • Dependent Children Who Did not Live with Taxpayer

  • Dependents - Parents

  • Dependents - Other

Certain Business Expenses from Form 2106/2106-EZ

Health Savings Account Deduction

Penalty on Early Withdrawal of Savings

Alimony Paid

Individual Retirement Account (IRA) Deduction

Child Related Credits (other than related to EIC)*

  • Child and Dependent Care Expenses - Number of qualified persons (not listed as dependents) (Form 2441)

  • Qualified Child and Dependent Care Expenses (Form 2441)

Education Related Deductions and Credits*

  • Educator Expenses

  • Student Loan Interest Deduction

  • Tuition and Fees Deduction

  • Education Credits

Retirement Savings Contributions Credit

Residential Energy Credits

Additional Tax on IRAs, Other Qualified Retirement Plans, etc.

Federal Income Tax Withholding

EIC with no Qualifying Children

Excess Social Security and Railroad Retirement Tax Amount (RRTA) Tax Withheld

Federal Fuel Tax Credit

Schedule A Items:

  • Medical and Dental Expenses

  • Taxes*
    ▸ State and local income taxes or
    ▸State and local general sales taxes
    ▸ Real estate taxes
    ▸Personal property taxes
    ▸Other taxes

  • Interest*
    ▸ Home mortgage interest and points from Form 1098
    ▸ Home mortgage interest and points not from Form 1098
    ▸ Points not from Form 1098
    ▸ Mortgage insurance premiums
    ▸ Investment interest

  • Gifts to Charity*
    ▸ Gifts by cash or check
    ▸ Gifts other than by cash or check
    ▸ Contribution carryover

  • Job Expenses and Certain Miscellaneous Deductions*
    ▸ Unreimbursed employee expenses
    ▸ Tax preparation fees
    ▸ Other expenses

  • Other Miscellaneous Deductions

Employee Business Expenses (Form 2106 and/or Form 2106-EZ)*

  • Vehicle Expense

  • Parking, Tolls and Transportation

  • Travel Expenses

  • Other Business Expenses

  • Expense Reimbursements Not Reported on W-2

  • Meals and Entertainment