Pretend you are an IRS Revenue Agent and have been assigned Mr. Plummer’s tax return for examination
(audit). The return contains various entries which you will need to carefully examine.
This is not a group project. You should email me your responses to the questions before each class begins
on the dates specified below.
The return was filed on 4/15/2015 and contains the following forms and schedules: Form 1040 & Schedules
A, B, C & SE. It was prepared by the taxpayer himself on Turbo Tax. Assume it was filed with the IRS as
you see it, even though it contains some missing information. Assume it was signed by the taxpayer, and
had a W-2 attached to it issued by ABC Construction Corp., 555 South Victoria Ave., Ventura, CA and that
the W-2 was for $1,500,000.
Review Form 1040 and each schedule carefully. See if any of the information from one schedule might
relate to another schedule – in other words, given what you see in one schedule, does that information
correspond or conflict with information on another schedule.
What makes this exam different from most of your past exams at CSUN is that there is no right and wrong
answer. This project requires that you make certain inferences from the information you are provided and
then make some factual assumptions or suppositions about the taxpayer, his lifestyle, his assets, his
business dealings, his sources of income, his expenses, the nature of his business, the nature of his
This project requires you to use your common sense and everyday experiences, as well as your basic
business, accounting and tax knowledge. What I am looking for most is your analysis, followed by the
Prepare an Audit Plan
a. Prepare a list of twelve (12) deductions shown on the return that you want to audit. For each of these
deductions that you list, provide a one or two sentences for each explaining why you have identified the
deduction. In other words, explain why you feel there is a possibility the deduction may be improper/nondeductible, excessive/not reasonable, etc.
b. Prepare a list of five (5) income items shown on the return that you plan ask about during your interview
of the taxpayer or his representative. For each item, explain in one or two sentences why you selected
these items and what inferences you are drawing from the amount of income, from the manner in which it is
reported, from the label that is placed on it, from the category of income it falls under, etc.
3) Document Request and Background Research
c. For each of the 12 deduction items and 5 income items that you have selected for audit, list in a few
i. What documents you are requesting that the taxpayer provide to you during the audit appointment(s) for
each of the items you identified that you are examining/auditing.
ii. What public records you will review before your interview to be armed with information so that you know
whether the taxpayer or his representative is being truthful.
iii. What internal IRS reports/transcripts can you review in order to determine if the taxpayer reported all of
his income and to determine the source of his income in case the source is not clear on the return.
iv. With respect to the 12 deductions, make one or two assumptions of what the taxpayer might tell you or
the documents he might provide that would make the deduction entirely non-deductible (other than lack of
proof of payment) or partially non-deductible. Tell me what your assumption(s) is/are and how that would
influence the outcome of whether that particular expense is deductible.
v. With respect to the 5 income items, make one or two assumptions about what the taxpayer might tell you
about the source or nature of the income. In other words, give me one or two examples of what the
taxpayer might say that may lead you to believe that:
1. there may be other unreported income
2. there may be related persons or entities whose information may shed more light on this taxpayer and/or
his income from other sources. If so,
a. what information or documents will you ask for relating to such related persons or entities.
b. are there any related party documents you wish to review, if so please explain in one or two sentences
what these documents might be and what they might reflect about the taxpayer, his business dealings, etc.
4) The Pre-Audit Phone Call
Assume that you will be using a classic investigative technique – the Surprise Phone Call.
You call the taxpayer at his home or his work. You identify yourself, gently state that his 2014 return has
been selected for review, and that you are calling to set up an appointment in the next few weeks to meet
with him at his residence for a few hours. After he recovers from the initial shock of the news, you ask him if
he has few minutes to go over some preliminary matters before you come out so as to help narrow your
audit to no more than what is absolutely necessary. Assume he agrees to answer your questions.
List fifteen (15) questions you would like to ask in order of importance to pin the facts down before the
taxpayer gets a chance to speak to a representative. Remember, once he hires a representative, your
questions will primarily be answered by the representative.
Good luck and keep in mind the following general directives of the IRS:
The mission of the IRS is to “Provide America’s taxpayers top quality service by helping them understand
and meet their tax responsibilities and by applying the tax law with integrity and fairness to all.” This
mission statement describes the IRS’ role and the public’s expectation about how the IRS should perform
• In the United States, the Congress passes tax laws and requires taxpayers to comply.
• The taxpayer’s role is to understand and meet his or her tax obligations• The IRS’ role is to help the large majority of compliant taxpayers with the tax law, while ensuring that the
minority who are unwilling to comply pay their fair share.
How this plays out in the tax audit world is as follows:
1. It is the Revenue Agent’s duty to help achieve the taxpayer’s compliance with the tax laws.
2. The Revenue Agent must be courteous but firm with taxpayers
3. When a tax issue can go either way, the Revenue Agent must protect the interests of the government.
4. Unless otherwise told to do so, a Revenue Agent must not spend too much time on matters that will not
yield tax dollars for the government.
5. The Revenue Agent must try to close the case in 6 months or less when possible, and if that is not
possible, he/she must articulate to management why additional time is needed.
And these more specific guidelines from the Internal Revenue Manual [next page] Section 18.104.22.168 (08-01-2007) — In-depth Pre-contact Analysis
1. The examiner is responsible for determining the scope of the audit, beginning with the issues identified
by the classifier on the classification check sheet. The examiner must perform a pre-contact analysis
including a thorough review of the case file to identify large, unusual, or questionable items (LUQs) beyond
those selected on the classification check sheet. The examiner should take the following actions:
A. Review the complete tax return including line items, credits, the balance sheet, elections and schedules,
and any other items attached to the return.
B. [omitted] C. Review internal and external data from the following sources:
Asset locator / people locator, and
D. [omitted] —————————————
Section 22.214.171.124.1 (08-01-2007) – Large Unusual Questionable Items (LUQs) Defined
1. The definition of a large, unusual, or questionable item will depend on the examiner’s perception of the
return as a whole and the separate items that comprise the return. Some factors to be considered when
identifying LUQs are:
A. Comparative size of the item — an expense item of $6,000.00 with total expenses of $30,000.00 would
be a large item; however, if total expenses are $300,000.00, the item would not be generally considered a
B. Absolute size of the item — despite the comparability factor, size by itself may be significant. For
example, a $50,000 item may be significant even though it represents a small percentage of taxable
C. Inherent character of the item — although the amount of an item may be insignificant, the nature of the
item may be significant; e.g., airplane expenses claimed on a plumber’s Schedule C.
D. Evidence of intent to mislead — this may include missing schedules, incomplete schedules, misclassified entries, or obviously incorrect items on the return.
E. Beneficial effect of the manner in which an item is reported — expenses claimed on a business schedule
rather than claimed as an itemized deduction.
F. Relationship to other items — incomplete transactions identified on the tax return. For example, the
taxpayer reported sales of stock but no dividend income.
G. Whipsaw issues — occur when there is a transaction between two parties and characteristics of the
transaction will benefit one party and harm the other. Examples include alimony vs. child support, sale vs.
rental/royalty, employee vs. independent contractor, gift vs. income.
H. [omitted] I. Missing items — consideration should be given to items which are not shown on the return but would
normally appear on the returns of similar taxpayers. This applies not only to the examination of income, but
also to expenses, deductions, etc., that would result in tax changes favorable to the taxpayer