Many business owners are vaguely aware that problems with business taxes, including employment taxes or payroll taxes, can result in major problems for the company. Unfortunately, many business owners and responsible parties are unaware that issues with “trust fund taxes,” taxes held in trust by an employer for the U.S. government, can create personal liability. Personal liability means that your personal finances will be impacted by the tax debt.
Despite the potential for both personal and professional financial distress, far too many business owners seek to handle an IRS employment tax audit without the guidance of a tax attorney. Many entrepreneurs are confident in their abilities to talk through situations and may reason that they can go it alone. Unfortunately for these individuals, they soon discover that they cannot talk their way out of an investigation and must engage the IRS agent on their home turf. By the time this revelation occurs, the taxpayer is likely to have lost a significant amount of time that could have been used to prepare for the audit and its challenges.
Pre-Examination Analysis Is Exhaustive
Despite some sense that IRS auditors are experienced professionals who engage in audits, investigations, and examinations on a daily or near daily basis, many taxpayers would be shocked and surprised to see exactly how much work goes into pre-audit preparation. All examiners are required to prepare an audit plan at the outset of the investigation. The audit plan should, at minimum, address:
- Any agreements the taxpayer may have previously reached with the IRS.
- The scope of the examination including the specific issues the examination will target.
- A plan regarding the procedures that will be utilized for the examination.
- An estimate as to how long the examination is expected to last.
- Any other useful, relevant information
The taxpayer is provided with a copy of the audit plan. The taxpayer can utilize this document to better understand how he or she should prepare to meet the challenge of the audit.
Also during the pre-planning stage of the audit, the auditor will assess whether any LUQs (large, unusual, or questionable employment tax issues exist). At minimum, the agent is likely to assess all or part of the following filings to assess whether LUQ issues exist:
- Schedule M-1, Reconciliation of Income (Loss) per Books With Income per Return
- Schedule M-2, Analysis of Unappropriated Retained Earnings per Books
- Schedule M-3, Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 Million or More
- The first four pages of Form 1120, S. Corporation Income Tax Return
- Form 851, Affiliations Schedule
- Consolidated schedule of income and deductions,
- Statement of Other Deductions
The examiner is also instructed to review and assess other taxpayer information including historical tax filings and previously flagged potential employment tax issues.
Pre-Examination for a Tax Audit Also Includes Risk Assessment
All proposed examinations must include a risk assessment component. Risk analysis is first performed extremely early in the process during the initial planning phase of the examination. At this early stage, the Internal Revenue Manual holds that risk assessment can be conducted on the individual issues or on the overall case. A mid-cycle risk assessment is not required in all matters but may be mandatory for certain matters.
How Are “Work Papers” Utilized in Employment Tax Fraud Audits?
As partially described above and as part of the workup to bring an audit or investigation, the IRS auditor will produce an array of documents collectively known as “work papers.” Work papers should properly and adequately support all facets of the IRS’s position when the tax agency wishes to make adjustments to a taxpayer’s filings. Work papers are mandatory in every case the IRS takes on. Properly prepared work papers will address and support the IRS’s position regarding:
- Any position taken by the agency or issues appealed by the taxpayer.
- Any actions that were taken by the IRS.
- Provide support for any reports issued
- Provide a basis for review and assessment.
- Provide a clear paper trail regarding procedures utilized and the scope of the matter for future auditors.
While there is no requirement mandating their use, most examiners will utilize Employment Tax Lead Sheets (ETLS) when preparing work papers.
The work papers that are prepared will reflect the steps and measures actually employed during the examination. However, the IRS is generally known to avoid including “superfluous” documents or “irrelevant” data. While the IRS is free to characterize information in this way, a taxpayer may be well-served by filing a Freedom of Information request under FOIA to make an independent determination.
Working with an experienced tax lawyer can aid a taxpayer in making FOIA requests to obtain tax information and many other aspects of an employment tax audit. Dually certified tax attorney and CPA David Klasing may be able put his more than 20 years of tax experience to work for you regarding these and other tax issues. To schedule a reduced-rate consultation with one of the tax professionals of the Tax Law Office of David W. Klasing, call 800-681-1295 today.
