ROBERT E

2007 IRS REPRESENTATION UPDATE©

By Robert E. McKenzie

1. A Changing IRS

More Compliance Centers to Cease Processing Returns:

1.10 Because of electronic filing the IRS is gradually eliminating its return processing centers. The closure schedule is as follows.

Memphis & Holtsville no longer process
Philadelphia 10-2007
Andover 10-09
Atlanta 10-11

As of October, 2011 there will be 2 returns processing centers for business returns and 3 returns processing centers for individual returns. Each of the remaining compliance centers will continue performing correspondence audits and collection activities.

Commissioner Everson Resigns

1.15 IRS Commissioner Mark Everson resigned on April 18, 2007. Mr. Everson is leaving the IRS to become president of the American Red Cross. During his tenure with the IRS Everson dramatically increased IRS enforcement activity. Audits more than doubled and there was an even more dramatic increase in IRS enforced collection actions. Mr. Everson also shifted IRS audit resources to examine the returns of high income taxpayers. He also initiated an aggressive program to find and eliminate tax shelters.

New Director of the Office of Professional Responsibilty

1.20 Michael R. Chesman has been appointed as Director of the Office of Professional Responsibility .Chesman most recently served the IRS as Director of the Office of Taxpayer Burden Reduction, which he launched in 2001 before taking a position in early 2006 as senior vice president and general counsel with Ullico, Inc., an insurance and financial services holding company.

Earlier in his career, Chesman served in the IRS Chief Counsel’s Office and also worked as an attorney for Prudential Financial, where, in addition to other duties, he was in charge of the tax and employee benefits divisions of the Prudential law department. He is a graduate of the University of Virginia School of Law and Yale University.

New Circular 230 Rules

1.30 In January 2006 the Treasury and the IRS announced new Circular 230 rules. The proposed rules remain pending. The proposed revisions to would modify:

· the definition of practice,

· eligibility for enrollment,

· unenrolled practice, and

· the rules concerning contingent fees, conflicts of interest, standards with respect to tax returns and documents, affidavits and other papers, sanctions, discovery, publicity, and appeals.

The proposed regulations do not address the standards for written tax advice that were the subject of final amendments to the regulations issued in December 2004 and modified in May 2005. A hearing on the proposed regulations is scheduled for Wednesday, June 21, 2006 at 10 a.m., in the IRS auditorium.

IRS Expands Access to e-Services Products

1.40 Effective March 21, 2005 tax professionals who e-file any combination of five or more accepted individual and business tax returns in a calendar year were allowed to use these e-Services products: Disclosure Authorization, Electronic Account Resolution and Transcript Delivery. When first launched in the summer of 2004, the e-Services incentive products were reserved for those who e-filed 100 or more individual returns.

e-Services Products for Practitioners

1.50 e-Services is a suite of Internet products that allow third-party customers to conduct specific business activities with the IRS electronically and are an incentive product to promote IRS e-File. All users must register and provide information to be used online during secure sessions. Registration is confirmed via postal mail. A PIN is mailed directly to the registrant. Other secure features of e-Services are:

· Principals/responsible officials on the application can delegate access to individual e-Services.

· All users are authenticated against IRS records.

· Passwords must be changed every six months.

· Passwords are known only to the user.

· Every transaction is recorded.

· Transactions are reviewed for access violations.

Electronic Account Resolution (EAR)

1.60 Tax professionals using EAR can quickly resolve clients’ account problems by electronically sending and receiving inquiries about individual or business account problems, refunds, installment agreements, missing payments or notices. Tax professionals must have a power of attorney (Form 2848 only) on file before inquiring into a client’s account. Responses are delivered to a secure electronic mailbox within three business days. Use Disclosure Authorization to submit the Form 2848 to the IRS. Form 8655 authorizations may not be used to access EAR at this time.

Transcript Delivery System (TDS)

1.70 TDS resolves clients' need for return and account information quickly in a secure, online session. It allows eligible tax professionals, with a power of attorney (Form 2848 only) on file, to request and receive account transcripts, wage and income transcripts, tax return transcripts, and verification of non-filing letters for individual taxpayers and account transcripts for business taxpayers. Use Disclosure Authorization to submit the Form 2848 to the IRS. Form 8655 authorizations may not be used to access TDS at this time.

Other e-Services

1.80 Other e-Services products available to all tax professionals include:

e-Services Registration

Tax professionals who want to use any of the e-Services products must register online as individuals to create an electronic account. This is a one-time automated process where the user selects a username, password and personal identification number, or PIN. An on-screen acknowledgement confirms the successful initial registration process.

Preparer Tax Identification Number (PTIN)

Tax professionals may choose to use a PTIN, instead of a Social Security number on returns they prepare for clients. The PTIN application enables a preparer to apply for and receive online a PTIN or look up a forgotten PTIN.

IRS e-file Application

Applicants can complete and submit e-file applications online. Existing participants in IRS e-file can use it to update their applications. Principals of organizations can delegate e-Services authorities to other individuals by identifying them on their IRS e-file application.

Taxpayer Identification Number (TIN) Matching

TIN Matching is a pre-filing service offered to payers of income subject to backup withholding who submit any of six information returns (Forms 1099-B, INT, DIV, OID, PATR, and MISC). Payers must be listed in the IRS Payer Account File (PAF) database and must have filed information returns with the IRS in one of the past two tax years.

Interactive TIN Matching

Allows authorized payers to match up to 25 payee TIN and name combinations against IRS records and receive results within seconds.

Bulk TIN Matching

Allows authorized payers to match up to 100,000 TIN and name combinations and receive results within 24 hours.

2. TAXPAYER ADVOCATE

National Taxpayer Advocate Releases Report To Congress

2.10 In January 2007 National Taxpayer Advocate Nina E. Olson released a report to Congress. Internal Revenue Code § 7803(c)(2)(B)(ii)(III) requires the National Taxpayer Advocate to describe at least 20 of the most serious problems encountered by taxpayers. This year’s report describes 21 problems. In each case, the report includes the National Taxpayer Advocate’s description of the problem, the IRS’s response, and the National Taxpayer Advocate’s final comments and recommendations. This format provides a clear picture of which steps have been taken to address the most serious problems and which additional steps the National Taxpayer Advocate believes are required. The 21 problems described in the report are as follows:

1. Alternative Minimum Tax for Individuals. The National Taxpayer Advocate believes that the most serious problem facing taxpayers today is the complexity of the Internal Revenue Code, and the poster child for tax-law complexity is the Alternative Minimum Tax for individuals (AMT). The AMT is a parallel and complex tax structure that is imposed on top of the regular tax structure. While the AMT was originally designed to prevent wealthy taxpayers from escaping tax liability through the use of tax-avoidance transactions, most of the significant tax loopholes that enabled taxpayers to escape tax at the time the AMT was written have long since been closed. Today, the AMT is left to punish taxpayers for engaging in such “classic tax-avoidance behavior” as having children or living in a high-tax state. In the first instance, the AMT disallows the personal exemptions that parents are allowed to claim under the regular tax rules to reflect the additional costs they incur in raising children. In the second instance, the AMT disallows the deduction for the payment of state and local income, sales, and property taxes that taxpayers are allowed to claim under the regular tax rules to reduce “double taxation” at the federal and state levels on the same income. This, in a nutshell, is today’s AMT. The National Taxpayer Advocate recommends that Congress repeal the provisions of the Internal Revenue Code that pertain to the Alternative Minimum Tax for individuals.

2. The Tax Gap. The federal tax gap is one of the most serious problems facing taxpayers today, and it is one of the top two most serious problems facing tax administration. It is a problem for taxpayers because the average compliant taxpayer is paying thousands of dollars in extra tax each year to subsidize noncompliance by others. It is a problem for tax administration because the government is failing to collect an estimated $290 billion in revenue a year that is due (based on 2001 estimates). The National Taxpayer Advocate has long recommended three broad strategies to help close the tax gap:

· fundamental tax simplification, with an emphasis on making economic transactions more transparent;

· expanded third-party information reporting and, in certain situations, tax withholding on non-wage income; and

· improved IRS compliance initiatives that appropriately balance taxpayer service and enforcement.

This year, we reiterate the importance of those broad strategies and emphasize three specific goals that we think warrant particular attention:

· improving taxpayer service to meet the needs our nation’s taxpayers;

· ensuring that the IRS’s stepped-up enforcement and compliance activity proceeds successfully and without violating taxpayer rights; and

· revising federal budget procedures to ensure that decisions about IRS funding are made in a way designed to reduce the tax gap by explicitly aiming to maximize compliance with the tax laws, especially voluntary compliance, with due regard for protecting taxpayer rights and minimizing taxpayer burden.

3. Transparency of the IRS. Tax administration benefits from transparency, and the Freedom of Information Act (FOIA) requires the IRS to make certain procedures and guidance available to the public. Nonetheless, the IRS sometimes updates its procedures and guidance without timely making them available to the public. For example, it sometimes does not make available to the public: (1) updates to an internal version of the Internal Revenue Manual (IRM), (2) signed or unsigned memos announcing changes in procedures or guidance, (3) procedures or guidance that serve to clarify or expand upon the IRM, and (4) legal advice that contradicts legal analysis that is available to the public. While not all such nondisclosures violate the FOIA, the National Taxpayer Advocate believes that transparency in tax administration is essential to assure taxpayers that the tax laws are being administered fairly. It is also necessary to ensure that IRS employees, taxpayers, and practitioners know which procedures and guidance are the most current. Moreover, the IRS can benefit from the feedback that an increase in transparency might generate. Although the IRS has generally improved its transparency in recent years, further improvements are needed.

4. True Costs and Benefits of Private Debt Collection. After two years of monitoring the implementation of the IRS’s Private Debt Collection (PDC) initiative, the National Taxpayer Advocate is recommending that Congress repeal the IRS’s authority to enter into contracts with private collection agencies (PCAs) to collect delinquent federal tax debts. The PDC initiative was premised on three concepts: (1) the initiative would be cost effective, (2) private agencies would only work easy cases, and (3) the IRS is similar to other federal agencies that have used PCAs successfully. The IRS now acknowledges that it can collect these delinquent accounts more efficiently than PCAs. Additionally, the Taxpayer Advocate Service (TAS), which has assisted in monitoring the program, has observed a significant amount of complexity in the cases assigned to PCAs (including unresolved delinquent return investigations) for which PCA employees are not adequately trained. Further, the analogy of the IRS to other federal agencies is a poor one. Unlike other federal agencies, the IRS has a nearly $2 billion collection budget with thousands of collection employees. In contrast, PCAs at this stage of the initiative are using 75 employees to collect on these accounts, and the IRS is using 65 employees to monitor them. The IRS with its vast resources can do what 75 PCA employees can do. The initiative also carries hidden costs to customer service, to the transparency of IRS operations, to the principle of consistent treatment for similarly situated taxpayers, and to the IRS’s long-term goal of tax compliance. TAS has observed examples of these costs, including poor customer service to multilingual taxpayers, PCA operational plans being withheld from public disclosure, and PCA collection scripts through which PCA employees attempt to manipulate taxpayers. The impact to tax compliance is uncertain. However, the National Taxpayer Advocate believes the IRS has risked much for a small return, if any, on its investment.

5. Early Intervention in IRS Collection Cases. The lack of early, meaningful interventions by the IRS on delinquent tax accounts contributes to long-term financial problems for many taxpayers and costs the government billions of dollars in lost revenue. It appears that far too many IRS collection accounts are relegated to “currently not collectible (CNC)” status, or remain in “open” status for prolonged periods, even when taxpayers have attempted to resolve the debts through installment agreements or offers in compromise. The National Taxpayer Advocate recommends the IRS revise its methods of prioritizing and assigning collection cases. The IRS should also do more to initiate meaningful, personal contacts with taxpayers and offer more flexibility in providing realistic payment options to taxpayers trying to resolve their problems.

6. IRS Collection Payment Alternatives. The IRS does not fully utilize the available collection payment alternatives, such as installment agreements and offers in compromise, to resolve delinquent tax accounts. This approach means many account problems are not addressed timely, fostering additional liabilities for the taxpayer and substantial amounts of lost revenue for the government. Virtually any debt-collection operation will acknowledge that as delinquent accounts receivable age, their collection potential declines. Yet it appears that as IRS collection cases age, IRS policies and procedures make it very difficult for taxpayers to obtain reasonable collection alternatives, with the result that the IRS often collects nothing. The National Taxpayer Advocate recommends the IRS revise its policies to ensure that determinations of reasonable collection potential used in case decisions are actually reasonable and realistic. The IRS should establish more flexible installment agreement and offer in compromise acceptance policies to improve revenue collection and help bring taxpayers back into the ranks of the voluntarily compliant.

7. Levies. The IRS levy program is a necessary means of collection and, when used appropriately, is a fundamental component of tax enforcement. The National Taxpayer Advocate recognizes the IRS’s need to utilize automation to perform enforcement activities more efficiently, but is concerned that this automation comes at the expense of meaningful personal contact and quality taxpayer service. The IRS should only serve a notice of levy upon third parties after it has taken the necessary steps to ensure that taxpayers will not be needlessly harmed. For example, 84 percent of all Federal Payment Levy Program (FPLP) levies historically have involved Social Security payments to the elderly or disabled, many of whom are fully dependent on these benefits to cover their basic living expenses, yet the IRS does nothing to try to screen out vulnerable, low income taxpayers from this automated process. Other levy release and payment application procedures are ineffective and lead to additional harm for taxpayers. By employing more proactive approaches, such as removing potential hardship cases from FPLP, the IRS can achieve the appropriate balance between enforcement and taxpayer service.

8. Centralized Lien Processing. In 2005, the IRS consolidated 33 geographically dispersed lien units into a single Centralized Case Processing Lien Unit (CCP-LU) located at its Cincinnati campus. The National Taxpayer Advocate is concerned that centralization has encroached on taxpayer rights and has increased the burden on both taxpayers and the IRS. The IRS has continued to experience difficulty timely providing notice of appeal rights and timely releasing liens under the new lien processing structure. Taxpayers and other IRS employees have experienced problems reaching the CCP-LU in the first place. The National Taxpayer Advocate recommends, among other things, that the IRS reexamine whether centralization is more cost effective and provides better service to taxpayers than the previous local lien desk structure and that the IRS conduct a comprehensive cost analysis of the centralized lien processing system.

9. Collection Issues of Low Income Taxpayers. The IRS’s collection operations fail to provide the meaningful services that low income taxpayers need to meet their obligations regarding federal tax delinquencies. The IRS frequently does not offer personal contacts and flexible payment options, even though many low income taxpayers require this type of service to fully and timely resolve problems. The IRS routinely gives very low priority to collection cases involving low income taxpayers and generally provides “service” on these accounts through computer-generated collection notices and automated levies. Frequently, cases involving low income taxpayers are simply set aside as “not collectible” even if the taxpayers are seeking alternative payment options. The taxpayers may also be subjected to automated levies on retirement and disability income sources, often without actual prior notice, even in situations where the taxpayers are surviving on incomes below or near the poverty level. Without the means to secure adequate representation, low income taxpayers can easily find themselves lost in a tax system that appears indifferent, uncaring, and sometimes hostile.

10. Excess Collections. The Excess Collections File (XSF) is a cumulative file within the IRS’s Integrated Data Retrieval System (IDRS) which reflects payments that either cannot be identified or cannot be applied to a specific taxpayer account. Both the Taxpayer Advocate Service (TAS) and the Treasury Inspector General for Tax Administration (TIGTA) have found that the IRS routinely moves funds into the XSF with very little research or contact with the taxpayer to ascertain whether a taxable return should be filed, and if so, where such funds should be applied. As a result, the IRS cannot properly determine whether it has collected the correct amount of tax due or owes the taxpayer a refund. The National Taxpayer Advocate recommends that the IRS make meaningful personal contact with taxpayers at the earliest possible stage and conduct substantive research to assist when such contact cannot readily be established. In doing so, the IRS will more effectively fulfill its fiduciary responsibility for these funds, reinforce voluntary compliance, and instill public confidence in the tax system.

11. Small Business Outreach. There are 45 million small business or self-employed taxpayers in the tax system today. These taxpayers use a wide range of services and products, and are increasingly diverse in terms of education, language, and geography. Small business taxpayers must deal with complex tax laws and regulations in order to satisfy their tax obligations and filing requirements. Many of these taxpayers cannot afford professional advice, and the IRS’s Small Business/Self-Employed division (SB/SE) is not adequately helping them understand and comply with their tax obligations. The single largest component of the tax gap, about 44 percent, is attributable to underreporting by self-employed taxpayers. The National Taxpayer Advocate urges the IRS to conduct research to assess the characteristics and needs of small business owners and self-employed taxpayers and to develop an integrated strategic plan to enhance the scope and effectiveness of its outreach and education to these taxpayers.

12. Oversight of Unenrolled Return Preparers. Taxpayers are harmed by the absence of a comprehensive federal program to regulate unenrolled return preparers (i.e., those who are not Certified Public Accountants, attorneys, enrolled agents, or enrolled actuaries). The National Taxpayer Advocate has repeatedly raised concerns about the lack of IRS oversight of unenrolled return preparers. However, the IRS has declined to support such a system, and none is currently in place. Nor does the IRS effectively monitor tax practitioners with its current administrative capabilities. Even when a member of the public or an IRS employee identifies potential preparer misconduct, the IRS does not have an effective system to receive and track complaints. The National Taxpayer Advocate also recommends that the IRS move forward on revisions to the regulations under IRC §7216 and reevaluate proposed changes to Circular 230, which would eliminate the ability of unenrolled return preparers to engage in limited practice before the IRS.

13. Correspondence Delays. The IRS’s correspondence policy masks systemic delays with quality measures that do not reflect actual correspondence timeliness to taxpayers. In FY 2005, the IRS issued 2.9 million “stall” letters informing taxpayers to expect additional delays beyond the standard 30-day response period. Rather than balancing resources to answer taxpayer correspondence more quickly, the IRS has automated the “delay-notification” process. Meanwhile, taxpayer satisfaction surveys continue to show that lack of “timeliness” is a major source of taxpayer dissatisfaction. TAS has also identified a disparity between the volumes of English and Spanish-language IRS letters, suggesting a lapse in service to the Spanish-speaking population. The National Taxpayer Advocate recommends that the IRS revise its measures for timeliness to reflect reasonable taxpayer expectations, enhance correspondence staffing levels, and take greater strides toward communicating with Spanish-speaking taxpayers in their primary language.

14. Disaster Response and Recovery. Over the years, the IRS has successfully responded to many disasters by, for example, providing and staffing toll-free FEMA phone assistance lines for Hurricane Katrina victims and answered approximately 950,000 calls. However, the IRS has room for improvement in planning for disaster relief. The National Taxpayer Advocate recommends the IRS establish a permanent disaster response team composed of employees and managers with expertise in individual, corporate, and small business tax matters. This team would operate in coordination with the Directors of the Federal Emergency Management Agency and Homeland Security.

15. Concerns about the IRS Office of Appeals. The IRS Office of Appeals has centralized work on appeals of certain examination and collection cases at IRS campuses. While this strategy can reduce cycle time, it emphasizes telephone or correspondence contacts and limits taxpayer opportunities for a local hearing with Appeals. This is especially true for “pro se” taxpayers who lack legal representation, may not fully understand the process, and fail to properly submit technical documents and narratives. In addition, Appeals is not aggressively pursuing use of Alternative Dispute Resolution (ADR) programs to resolve cases. The National Taxpayer Advocate urges Appeals to adequately notify taxpayers of the Appeals process and their rights to a face-to-face or local office meeting and to develop short and long-term strategies to promote use of ADR programs.

16. Correspondence Examination. The IRS increasingly uses correspondence examinations for audits of high income individuals, though there are indications that these examinations are better reserved for interviews or field audits. The IRS’s reluctance to discuss issues by telephone and the high volume of unassociated mail from taxpayers have led to premature audit closures. The IRS also makes inappropriate use of the combination letter, which compresses the timeframe taxpayers have to resolve disputes, and directs its processing employees to try to persuade taxpayers not to seek face-to-face meetings to pursue their appeal rights. The National Taxpayer Advocate urges the IRS to review the correspondence examination process with these concerns in mind, reduce the volume of unassociated mail, and establish better communication channels to prevent premature closures.

17. IRS Implementation of Math Error Authority Impairs Taxpayer Rights. Taxpayers who are summarily assessed additional tax via a “math error” notice may not be afforded the same rights as those assessed additional tax through normal IRS deficiency procedures. Math error authority allows the IRS to summarily assess tax before a taxpayer has the opportunity to challenge the assessment in the U.S. Tax Court. Because math error assessments are not subject to judicial review before the tax is paid or collected, the Internal Revenue Code only allows the IRS to use these assessments in specific, narrow circumstances. However, the IRS has exceeded this limited authority by issuing math error notices in cases that go beyond these specified circumstances. In addition, math error notices sent to taxpayers do not include the level of detail that Congress intended. The IRS should improve the notice language and format to ensure that taxpayers understand what changes were made to their tax returns and why, and refresh the training of its employees on the appropriate use of math error authority.

18. Limited English Proficient (LEP) Taxpayers: Language And Cultural Barriers To Tax Compliance. As the LEP population grows, so does the number of LEP individuals in the workforce who are required to file tax returns and need to interact with the IRS. The IRS currently offers limited services for non-English speaking taxpayers, with the majority of those services offered only in Spanish. The National Taxpayer Advocate urges the IRS to expand services to other LEP language groups, educate taxpayers about the availability of these services, and develop a process to determine a taxpayer’s language preference at the outset of his or her interaction with the IRS.

19. Taxpayer “No Response” Rates. The IRS relies almost exclusively on standardized paper correspondence to communicate with taxpayers. In many instances, taxpayers do not respond to IRS notices or requests for information, resulting in downstream consequences for both the IRS and the taxpayer. According to practitioners, taxpayers’ reasons for failing to reply to IRS requests are almost as complex as the tax code itself. While the problem of “no response” occurs among individuals, businesses, and tax-exempt organizations, and at all income levels, the IRS does not know the magnitude of the problem. Generally, the IRS does not track the number of taxpayers that do not respond to notices, how many taxpayers try to respond, or how many notices are undelivered. If a taxpayer fails to respond to an initial notice but contacts the IRS later, the IRS must engage in a significant amount of rework, while the taxpayer may have to expend additional time and money. The IRS could reduce costs and ease taxpayer burden by working to improve the taxpayer response rate.

20. Reasonable Accommodations for Taxpayers with Disabilities. Taxpayers with disabilities often find themselves attempting to navigate and comply with a complex tax system that has not been designed to provide equal access. The National Taxpayer Advocate recommends that the IRS create a disability website (containing information about IRS accommodations and deductions and credits available to taxpayers with a disability, their caretakers, and employers) and publicize IRS accommodations on forms, publications, and notices.

21. Injured Spouse Allocations. If married taxpayers file a joint federal tax return claiming a refund and one spouse has an outstanding federal tax debt, unpaid child support, debts owed to other federal agencies (e.g., student loans from the Department of Education), or state income tax obligations, the IRS will offset the couple’s refund against these debts. The spouse who is not liable for the debt can avoid having his or her portion of the refund offset against the debt by filing Form 8379, Injured Spouse Allocation, with the IRS. However, taxpayers who request injured spouse relief may be burdened by lengthy processing times or IRS calculation errors. The IRS can take as long as 14 weeks to process a request for injured spouse relief and is more likely to make an error when calculating the allocation since the IRS computes the refund manually. The National Taxpayer Advocate urges the IRS to identify and address the reasons for the lengthy processing time and to develop a system of calculating injured spouse allocations automatically, rather than manually.

The Most Litigated Tax Issues

2.20 IRC § 7803(c)(2)(B)(ii)(X) requires the National Taxpayer Advocate to identify the ten tax issues most often litigated in the federal courts and to classify those issues by the category of taxpayer affected. The cases reviewed were decided during the fiscal year that began on June 1, 2005, and ended on May 31, 2006. The following are the most litigated as determined by TAS:

1. Collection Due Process Hearings under Internal Revenue Code §§ 6320 and 6330. Since 2003, Collection Due Process (CDP) has been the most frequently litigated tax issue in the federal courts. CDP hearings provide taxpayers with an impartial review by the Office of Appeals of the IRS’s decision to file a lien or to undertake a levy action. At the hearing, a taxpayer may raise collection alternatives, including spousal defenses under IRC § 6015, and in certain circumstances may dispute the underlying liability. Appeals’ determinations are subject to judicial review. In the 195 cases we reviewed, some taxpayers continued to raise frivolous issues. Other cases involved significant issues pertaining to the scope of judicial review – including the standard of review, the application of administrative law and the Administrative Procedure Act, the admissibility of evidence outside of the administrative record, the impartiality of the Appeals hearing officer, and the opportunity to have a face-to-face CDP hearing. Taxpayers wholly prevailed in 15 cases. As a result of one appellate court’s ruling, the National Taxpayer Advocate is recommending a legislative change to IRC § 6330 to require the Appeals Officer to determine as part of the CDP hearing whether it would be uneconomical to proceed with levy.

2. Gross Income under Internal Revenue Code § 61 and Related Code Sections. The question of what constitutes gross income remains a source of confusion for many taxpayers. This confusion is illustrated by the 106 cases we identified where gross income was at issue. These cases can be separated into two major categories: (1) income includible in gross income and (2) income specifically excluded from gross income by statute. Some of the statutory exclusions include awards and settlements, disability and Social Security benefits, and discharge of indebtedness income. Although no clear patterns emerged from the cases, it is clear that the meaning of the term “gross income” remains an area of confusion and contention between taxpayers and the IRS.

3. Summons Enforcement under Internal Revenue Code § 7604 and Related Code Sections. Internal Revenue Code §§ 7602(a), 7604(a), and 7609(a) grant the IRS authority to summon the production of books, records or testimony from witnesses when investigating either a civil or criminal tax liability. We identified 101 cases relating to summons enforcement, which is more than double the number of cases we identified in the preceding year. Generally, the burden on the government to demonstrate the validity of the summons is minimal and the burden on the taxpayer to demonstrate the illegality of the summons is formidable. Accordingly, of the 101 cases reviewed, the taxpayers prevailed in only three cases, and five additional cases resulted in split decisions. As the IRS continues to step up its enforcement actions, it appears the IRS will rely heavily on the summons enforcement tool, and we expect federal courts to see continued growth in these cases. III-1

4. Accuracy-Related Penalty under Internal Revenue Code § 6662(b)(1) and (2). Taxpayers who underpay the required amount of income tax are subject to an accuracy-related penalty if the underpayment is attributable to the taxpayers’ negligence or results in a substantial understatement of income tax. The penalty can be avoided if the taxpayer is able to demonstrate reasonable cause for the underpayment. We identified 92 cases that involved either the negligence penalty under IRC § 6662(b)(1) or the substantial understatement penalty under IRC § 6662(b)(2). Taxpayers prevailed in whole or in part in 29 of those cases, arguing either that the underlying income was not taxable or that there was reasonable cause for the underpayment of tax.

5. Failure to File Penalty under Internal Revenue Code § 6651(a)(1) and Failure to Pay Estimated Tax Penalty under Internal Revenue Code § 6654. The failure to file penalty is mandatory unless the taxpayer can demonstrate that the failure to timely file a tax return was a result of reasonable cause and not due to willful neglect. The penalty for failure to pay estimated taxes is mandatory unless the taxpayer can meet one of the exceptions listed in the statute. We identified 78 decisions involving these two penalties. In these cases, taxpayers rarely avoided the failure to file penalty based on reasonable cause or the estimated tax penalty based on statutory exceptions. In fact, the IRS prevailed in all but two cases; one other case resulted in a split decision.

6. Frivolous Issues Penalty under Internal Revenue Code § 6673 and Related Appellate-Level Sanctions. The courts may impose penalties against taxpayers for maintaining a case primarily for delay, raising frivolous arguments, or unreasonably failing to pursue administrative remedies. We identified 73 cases involving the IRC § 6673 penalty, including 56 decided at the trial court level (55 by the Tax Court and one by a U.S. district court) and 17 decided by a U.S. Court of Appeals. At the trial court level, the IRS sought imposition of the penalty or the court imposed the penalty sua sponte in 42 cases; taxpayers prevailed in only 10 of those cases. In 14 other cases, the court sua sponte warned the taxpayer that the penalty likely would be imposed if the taxpayer made similar arguments in the future. The government prevailed in all 17 cases in which taxpayers appealed the imposition of the IRC § 6673 penalty to the applicable U.S. Court of Appeals. Apart from the IRC § 6673 penalty, U.S. Courts of Appeals considered the imposition of separate appellate-level sanctions in at least 25 cases and imposed such sanctions in 22 of those cases.

7. Trade or Business Expenses Under Internal Revenue Code § 162(a) and Related Code Sections. As in previous years, the deductibility of trade or business expenses was one of the ten most litigated tax issues in federal courts. We identified 68 litigated cases that included a trade or business expense deductibility issue. The courts affirmed the IRS position in more than 76 percent of these cases, while taxpayers prevailed less than five percent of the time. The remaining cases resulted in split decisions. Notably, three cases involved taxpayers who were involved in a multi-level marketed tax scheme promising trade or business deductions for numerous personal expenses. In all, at least 50,000 taxpayers participated in this scheme marketed by “Renaissance, The Tax People.” The individuals behind this scheme have been arrested and are being prosecuted in federal court.

8. Relief from Joint and Several Liability for Spouses under Internal Revenue Code § 6015. Spouses filing joint federal income tax returns are jointly and severally liable for any deficiency or tax due. IRC § 6015 provides relief from joint and several liability. We reviewed 51 federal court opinions involving relief under IRC § 6015, with 39 decided in favor of the IRS, 10 in favor of the taxpayer, and 2 split decisions. While the courts considered many factors in determining the appropriateness of relief under IRC § 6015, the most significant this year was whether the requesting taxpayer had actual or constructive knowledge of the deficiency.

9. Family Status Issues Under Internal Revenue Code §§ 2, 21, 24, 32, and 151. Family status disputes involve exemptions, credits, and filing status claimed by taxpayers when they prepare their federal tax returns. These provisions are fundamental components of the tax code, yet they have complicated and sometimes conflicting eligibility standards. Because of this complexity, tax filing can be a difficult and confusing exercise for low and middle income families. Taxpayers who wish to claim the family status credits and deductions often do not understand the qualification requirements or how to properly satisfy them. Further, such taxpayers often lack legal representation when they go before the courts. Litigated cases often include multiple family status issues with similar factual determinations. We identified 46 cases involving these issues. More than two-thirds dealt with multiple family status issues, with the determination of one issue often affecting others; for example, a denial of the dependency exemption will result in the summary denial of the child tax credit and may jeopardize eligibility for head of household filing status and the child and dependent care credit.

10. Charitable Contribution Deduction Issues Under Internal Revenue Code § 170. Subject to certain limitations, taxpayers can take a deduction from their adjusted gross income for contributions of cash or other property to charitable organizations. Contributions must be made to qualifying organizations, and taxpayers must substantiate the contributions. For the 2006 Annual Report to Congress, we identified 26 cases in which the charitable contribution deduction was at issue. The IRS prevailed entirely in 19 cases, and 7 cases produced split decisions. Most cases involved the taxpayer’s inability to substantiate the contributions. However, courts applied the Cohan doctrine, which allows the court to arrive at a deduction amount in cases where the taxpayer proved a deduction was made but failed to keep precise records.

3. ENFORCEMENT

Highlights of 2007 Enforcement

3.10 Enforcement highlights for the fiscal year ended September 30th include the following:

Increased Enforcement Revenues

The bottom line for IRS enforcement efforts shows that dollars collected rose again last year. There’s a strong trend line going up. Fiscal 2005 was a watershed year for the IRS, with a number of big initiatives that helped push enforcement revenues up 10% to $47.3 billion. In Fiscal 2006, enforcement revenues – the monies collection, examination, and document matching activities – increased to a record $48.7 billion. Exam dollars were down slightly this year because of the big bump from the Son of Boss settlement initiative in 2005. Even with that, overall dollars collected jumped nearly 3% in 2006 principally because of a strong rise in collections.

Individual Enforcement

3.20 The individual enforcement categories bear out the significance of invigorated enforcement efforts. And all these numbers are for fiscal year 2006 that ended September 30:

Total individual returns audited increased by over 6% to 1,293,681 in 2006 from 1,215,000 in 2005. That’s the highest number since 1998. Some people have dismissed the audit increases because of use of correspondence, or letter exams. There was an even bigger increase in field exams – these are the traditional, sit-down audits. The number of field audits increased nearly 23% in 2006 from the previous year, and they climbed by more than half from the level in 2004.

High Income Taxpayers

3.30 An important part of enforcement effort has targeted high-income taxpayers. There has been lot of emphasis in increasing audits in this area If you earn more than $100,000 or you’re a millionaire, you’re a lot more likely to be audited these days than just a few years ago. Audits of individuals with income of $1,000,000 and higher increased to 17,015 from 12,835, a nearly 33% increase in just one year. About 1 in every 16 of these taxpayers faced audits last year. If you’re earning that kind of money and the IRS notices a problem, you are going to hear from it.

Audits of individuals with incomes over $100,000 surpassed 257,000, an 18% increase from 2005. That’s the highest figure in more than a decade, and well over double the 92,000 completed in fiscal year 2001.

S Corporations, Partnerships And Small Businesses

3.40 There was an increase in efforts to review S corporations and partnerships while other activity involving small business and large corporations remained relatively stable. The business numbers reflect that IRS has placed more emphasis in the growing area of these flow-through returns involving S corporations and partnerships:

· Audits of S corporation returns increased to 13,984 from 10,417, a 34% increase. This is the highest level since 2000.

· For partnerships, audits of these flow-through returns increased to 9,777 from 8,489, a 15% increase. This category is at the highest level since 1998.

· Audits of small businesses organized as corporations remained about the same. 17,871 audits were completed in 2006, up slightly from 17,858 in 2005.Both of these figures are more than double the 7,294 audits of small businesses in 2004.

Large Corporations

3.50 Audits of larger corporations – those with assets over $10 million – dipped by 2.2%, to 10,591 from 10,829 in 2005.While down slightly this year, audits remain up nearly 50 percent from 2003.

Tax Exempts

3.60 The IRS has placed renewed attention and added resources in the charitable arena to help protect the integrity and maintain faith in the charitable sector. The results show IRS is taking important steps to combat abuse in exempt organizations. Exempt Organization area audited 7,079 returns in 2006, an increase of 43% from the previous year. That is the highest level since 2000.

New Initiatives

3.70 In addition to increased exam activity, IRS introduced a new program in 2004 using non-traditional compliance contacts to expand enforcement presence within the tax-exempt community. These compliance contacts have been instrumental in addressing problem areas in sectors such as hospitals, executive compensation and credit counseling. In Fiscal 2006, IRS completed over 5,200 of these new compliance contacts, over and above the traditional examination program. This is a 31% increase from the previous year. Before 2004, there were none of these contacts.

Collection Enforcement

3.80 Overall, some of our most common enforcement tools at the IRS also showed increases:

In collection activities, levies and liens continue to top their 1998 levels. Levies increased by 36% to 3,742,276.Liens rose nearly 20% to 629,813.

Electronic Filing

3.90 Electronic filing by individuals continued to increase, up 6% (3 percentage points) to 54% of all individual returns.

IRS Enforcement Activities Continue To Recover Enhanced Enforcement Has Not Come At The Expense Of Service

Table 9. Examination Coverage: Recommended and Average Recommended Additional Tax After Examination, by Type and Size of Return, Fiscal Year 2006
		Returns examined
Type and size of return	Returns filed in		Percentage
	Calendar Year 2005 [1]	Total	covered	Field [2]	Correspondence
	(1)	(2)	(3)	(4)	(5)
United States, total	176,941,072	1,406,282	0.8	416,142	990,140
Taxable returns:
Individual income tax returns, total [3]	132,275,830	[4] 1,283,950	1.0	302,785	981,165
Nonbusiness returns:
Form 1040A with TPI under $25,000 [5, 6]	31,675,935	159,561	0.5	9,219	150,342
All other returns by size of TPI [6]:
Under $25,000	20,295,694	302,168	1.5	16,434	285,734
$25,000 under $50,000	30,828,932	191,150	0.6	44,095	147,055
$50,000 under $100,000	26,463,973	163,711	0.6	61,662	102,049
$100,000 or more	12,893,802	166,839	1.3	56,717	110,122
Business returns by size of TGR [7]:
Under $25,000	3,376,943	127,603	3.8	19,801	107,802
$25,000 under $100,000	3,867,743	80,792	2.1	38,722	42,070
$100,000 or more

2007 REPRESENTATION UPDATE©