In late 2016, a taxpayer with a stellar tax record was facing a deadline to respond to an automated notice of a correspondence exam of the Schedule C expenses on his 2014 return. The IRS had given him until December 25 to substantiate them. So, that Christmas Eve, the taxpayer sent off a lengthy fax to the IRS. It contained more than enough information from which the agency could readily deduce that his business and expenses were legitimate and that no further action was necessary—or so the taxpayer thought. In late 2017, the IRS issued another automated correspondence exam notice of the Schedule C expenses on the taxpayer’s 2015 return.
The taxpayer had dutifully paid his taxes since he was in college. Now a college professor, he had no reason to suspect that he would become the target of an IRS audit; after all, most of the business expenses in both tax years related to a book that had been published by a major academic publisher in 2016. The book was the publisher’s lead title that fall, appearing on page one of its catalog and strategically released just days before a major motion picture on the same subject. A book by Supreme Court Justice Stephen Breyer appeared on page four of the same catalog.
In 2014 and 2015, the tax years under audit, the professor’s book was still a work in progress. He had considerable expenses in those years, especially during a period when a prestigious university invited him to work on the book as an uncompensated visiting scholar. Because he had yet to receive an advance for the book, the absence of directly offsetting revenue in both years triggered the IRS Discriminant Index Function (DIF), a computerized scoring system the agency uses to select returns for examination. The roboaudit was on.
The subsequent audit turned into an unending nightmare for the professor, who is now awaiting his day in Tax Court. He has spent countless hours searching for and providing documentation; itemizing and explaining the expenses in painstaking detail; briefing issues; filing complaints with high-level IRS managers and the Commissioner; and enduring a grueling six-hour line item interrogation during an appeals hearing. When the appeals officer’s decision finally arrived in early 2020, it had reduced the initial IRS adjustments by some 70% on the 2014 return and 90% on the 2015 return, but still contained major errors. The professor had come to understand why so many taxpayers despise the IRS.
The Automated Correspondence Exam
In fiscal year 2018, the IRS reported conducting nearly 75% of its audits by mail (IRS Data Book, 2018). In April 2019, the Government Accountability Office (GAO) reported that the IRS had failed to follow three fundamental recommendations for the automated correspondence exam program that the GAO had made in fiscal year 2014: “develop clear objectives for the correspondence audit program, ensure that program measures reflect objectives, and link measures with IRS-wide compliance goals” (GAO, Priority Open Recommendations: Internal Revenue Service, April 4, 2019). In other words, the correspondence audit program has no quality control, as the professor painfully learned.
The authors advocate that Congress cease all funding for correspondence audits until the IRS puts in place checks to ensure that the audits are professionally and fairly conducted, and that there are strict controls against abuses of authority.
After he sent the 2016 Christmas Eve fax, the next communication the professor received from the IRS was a Statutory Notice of Deficiency (SNOD), sent by certified mail to the taxpayer’s old address even though he had notified the IRS of his current address. While the SNOD had been forwarded by the Postal Service, an earlier letter, also sent by the IRS to the wrong address, had not been. When the IRS did not receive a prompt reply to the letter that the professor had not even received, the correspondence exam unit quickly issued the SNOD.
The SNOD is a powerful weapon for a correspondence unit because it enables the unit to unload the case without having to do an audit. The only remedy the taxpayer has after issuance of the SNOD lies in court.
As a practicing lawyer and former award-winning Justice Department trial attorney, the professor was not daunted by the prospect of going to court, but was intent on the IRS doing its job. With the help of a high-level representative of the Taxpayer Advocacy Service (TAS), an independent IRS unit that provides assistance to taxpayers, the professor compelled the IRS to rescind the SNOD due to administrative error. He was also ultimately successful in having the tax year 2014 case transferred from the Memphis, Tennessee correspondence unit to Los Angeles, the taxpayer’s home city, for an administrative appeals hearing.
In order to have an appeals hearing, however, the professor was told he would have to agree to extend the statute of limitations; otherwise, the SNOD simply would be reissued. Under the threat of another SNOD and with the promise of an appeals hearing, the professor signed the extension form.
Meanwhile, a different correspondence unit in Brookhaven, N.Y., was handling the 2015 audit. Initially, that unit demanded that the professor prove that he was not writing his book and practicing law as a hobby! Then, upon determining that the 2014 audit was under appeal, the Brookhaven unit encouraged the professor to appeal the 2015 examination as well, no doubt to unload the case. If he wanted to appeal, however, the professor was told that he would have to sign another extension of the statute of limitations. The professor relented and signed the extension form, and the 2015 case was sent to Los Angeles for appeal.
The professor’s case suggests that the IRS is a grossly dysfunctional, vindictive, and unaccountable agency in need of major reform.
The Administrative Appeal
Once the Los Angeles appeals officer received the 2014 case, she set a hearing date for it, instructing the professor to be thorough in submitting any additional documentation (“in an abundance of caution”) well in advance of the hearing. The professor gave up another weekend going through files and compiling records, lest any stone be left unturned. Off went another fax, with ¼ inch of backup documentation.
The additional documentation was “too voluminous,” said the appeals officer when she received the fax. So she would send the case back to the Memphis exams unit. Again, the professor protested and asked for the case to be assigned to an examiner in the Los Angeles area so that he could have a face-to-face meeting. Ultimately, the case was assigned to a local area examiner, but the appeals office refused to allow a meeting.
Meanwhile, the professor obtained a copy of his audit file through the Freedom of Information Act (FOIA). There, in the appeals officer’s log, he found a vindictive entry challenging the professor’s veracity in reporting to IRS managers her comment about the volume of the corroborating material. Based on this discovery, the professor asked that the case be reassigned to another appeals office so he could receive a fair hearing. The Director of Examination Appeals declined to transfer the case to another office, but did reassign the case to another appeals officer and supervisor.
The newly assigned appeals officer initially contacted the professor to set up the long-awaited appeals hearing, but was then ordered to cease communications. TAS had issued a Taxpayer Assistance Order (TAO) requiring that it be allowed to participate in the hearing. Excluding TAS from its hearings was such a high priority to the appeals unit that it referred the issue to the IRS Chief of Examination Appeals in Washington, D.C. And the appeals unit demanded that the professor agree to yet another extension of the statute of limitations, arguing that it needed one full year to resolve the case.
When the professor balked at the prospect of again extending the nightmare roboaudit, the very appeals manager who previously had been removed from the case issued SNODs for both of the tax years. Both form documents lacked any meaningful substantive explanation of the basis for the alleged deficiencies. And again—the professor’s name was spelled incorrectly!
In a telephone conference in which the professor was told the SNODs were forthcoming, a different manager made clear that if the professor had wanted an appeals hearing, he needed to “cooperate” In other words, he was being punished for failing to give the IRS yet another extension.
The Appeals Hearing
The issuance of the SNODs left the professor with no choice. He filed a petition in tax court. As is often the case, the case was then referred by IRS counsel back to the Los Angeles appeals office.
By the time the appeals hearing was finally held in the summer of 2019, the professor had submitted another FOIA request. From the response, it appeared that the new appeals officer had drafted the SNODs. In other words, the same IRS official whose actions resulted in the issuance of the SNODs in the first place would be officiating over the challenge to their legitimacy. Ironically, by this time, the Office of Appeals had undergone a name change: it was now officially the “Independent Office of Appeals.”
To add to the irony, at the time of the hearing, the appeals officer stated that his new supervisor was the very appeals officer who previously had been removed from the case. The presiding appeals officer also conceded that he had discussed the case with the removed appeals officer, both when he was first assigned to it and again in the week of the hearing. Then, having promised a two-hour meeting to review the facts and the law and the prospect of settlement, the appeals officer instead embarked on a six-hour fishing expedition. He conducted a line-by-line review of the professor’s expenses, the likes of which his accountant, a very seasoned tax practitioner and professor, had never seen in the appeals setting and believed to be retaliatory in nature.
The appeals officer insisted on substantiation for each expense, without regard to cost. He even inquired about a $7 charge the professor had incurred when he treated John Dean to coffee after the former White House counsel’s new book on Watergate was released in the summer of 2014.
The appeals hearing had started at 1:00 p.m. At 6:00 p.m., the lights automatically went out in the windowless conference room of the Los Angeles federal building in which it was being conducted. Not to be deterred, the IRS continued the hearing after hours in an office with natural light. In the end, the appeals officer agreed that the professor had substantiated all of his expenses with just a few exceptions for which the professor promptly provided the additional documentation requested. The appeals officer reserved judgment on only a limited number of deductions.
In mid-December 2019, with no decision or further action on the part of the appeals officer since the summer hearing, the Tax Court set a trial date. Shortly thereafter, the professor and his accountant invited the IRS lawyer assigned to the case to come meet with them to discuss informal discovery, hoping to resolve the remaining issues. She declined an in-person meeting on their college campus, citing IRS policy, and suggested a phone call instead. Coy about providing a document inexplicably missing from the IRS administrative file (“I don’t know if it exists”), she was curious about the professor’s expectations in pursuing the court case. “An apology from the Commissioner,” the professor said. “That’s not going to happen,” said the lawyer.
The IRS must adhere to the GAO’s recommendations and live up to the Commissioner’s promise to Congress.
In his confirmation hearings in 2018, Commissioner Charles Rettig, a highly experienced tax lawyer from Beverly Hills, pledged that if confirmed, his “overriding goal will be to strengthen and rebuild trust between the IRS, the American people, and their representatives in Congress.” While that may be the Commissioner’s goal, it would not appear to be shared by the IRS employees who participated in the professor’s roboaudit.
The professor’s case suggests that the IRS is a grossly dysfunctional, vindictive, and unaccountable agency in desperate need of major reform. Drastic times deserve drastic measures. Shutting down the agency entirely—the solution advocated by one presidential candidate as part of his 2016 campaign platform—is an impractically severe, if well-deserved solution. Viewed through the professor’s experience, however, a just and appropriate remedy would be a suspension of the automated correspondence audit program, pending a full investigation of its efficacy and fairness by the GAO and hearings before Congress.
The IRS must adhere to the GAO’s recommendations and live up to the Commissioner’s promise to Congress. Strict standards and controls must be applied to ensure that correspondence audits are not largely automated exercises that deprive taxpayers of their right to a fair and impartial process and subject them to abuses of authority.