Due to the current economy and the massive federal and state budget deficits, government agencies are much more aggressively auditing returns looking for money. Practioners are receiving more notices for review of returns and proposed changes on both the state and federal levels. Taxpayers and practitioners should be prepared to work with these auditors who are operating in an environment of increased examination tools and required disclosures.

 
Internal Revenue Service (IRS) examiners are better trained and currently have access to nearly 50 Marketing Segment Specialization Program Audit Guides that focus on developing highly trained examiners for a particular market segment. These guides contain common and unique industry issues, examination techniques, business practices, industry terminology and other information. The guides can be found at irs.gov/foia in the electronic reading room. More recently released guides cover segments such as the retail industry, new markets tax credit, low income housing credit and an update to certain areas of the partnership guide.

Over the past decade, providing transparency in tax filings has occurred through changes concerning reportable transactions, requirements to provide the Schedule M-3 and, most recently, the required submission by certain corporations of the Schedule Uncertain Tax Position (UTP). The Schedule UTP provides the IRS with information that affects taxpayers’ U.S. federal income tax liabilities pertaining to uncertain tax positions that they have taken. Under a five-year phase-in, beginning with 2010, certain domestic and foreign corporate taxpayers that have assets equal to or exceeding $100 million and are included in or issue an audited financial statement must file the UPT. For 2012, the asset threshold will drop to $50 million and starting with the 2014 tax year will drop to $10 million.

Generally, Schedule M-3 must be filed with entity tax returns if the total assets reported on Schedule L or the adjusted total assets equals or exceeds $10 million and the total amount of receipts is equal to or greater than $35 million. Increased transparency between book and tax reporting is the purpose of the form, along with the reduction in time to audit the tax return. This form provides a presentation method beneficial to the examiner to not only identify tax returns that should be examined, but also reflect issues that could be potentially subject to an audit. Additionally, trends in increased compliance risk can be identified. Identifying book-tax differences on a transaction-by–transaction basis is required by the Schedule M-3. Not only is this form beneficial for the examiners to use to identify returns and issues, but also assists with identifying trends.

 
A practitioner has a number of considerations when working with an auditor from the state or federal government.

• Verify that the agent is not a special agent if you do not know him or her personally.
• Confirm a timetable for the audit, concur on the scope of the audit and agree with the auditor as to the turnaround time for Form 4564, Information Documentation Requests.
• Maintain a record or chronological log of all files, workpapers and records provided to the examiner and have the auditor provide written indication for the receipt of documents.
• Contact the agent to arrange for the client to produce requested information in the event the agent contemplates making a third-party contact. 
• Disclose to the examiner obvious and/or significant errors present in the return based upon previous agreement with the taxpayer.
• Apply for the fast-track settlement procedure under Revenue Procedure 2003-40 if it is a Large and Mid-Size Business examination.
• Evaluate the consequences of not agreeing to sign a series 872 Form, Consent to Extend the Time to Assess Tax, should the agent request it.
• Request that a draft of the Revenue Agent’s Report be provided to confirm that the issues are consistent with prior discussions and agreement.

Tax compliance imposed through not only increased education of the examiners, but also by disclosure on the face of the filed forms, makes it more imperative than ever for practitioners to be prepared for a client audit.