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Part 4. Examining Process

Chapter 75. Exempt Organizations Examination Procedures

Section 28. Discrepancy Adjustments

4.75.28  Discrepancy Adjustments

4.75.28.1  (03-01-2003)
Overview

  1. The discrepancy adjustment program was established in order to reduce the number of referrals by TE/GE to Large and Mid-Size Business Division (LMSB), Small Business/Self-Employed Division (SB/SE), and Wage and Income Division (W&I) for what may require essentially a minor recalculation of tax. This program allows Exempt Organization (EO) examiners to make certain line item adjustments to federal income tax returns for issues arising from an examination of a return of an exempt organization with respect to tax adjustments to:

    1. Form 1040, U.S. Individual Income Tax Return; and

    2. Form 1120, U.S. Corporation Income Tax Return.

  2. An adjustment may arise when there is a discrepancy between an income tax return and facts developed during an examination of an exempt organization, or during other EO compliance activities such as compliance projects.

  3. These discrepancy adjustment procedures do not constitute an inspection of the taxpayer’s books and records under IRC § 7605(b).

  4. Discrepancy adjustments fall within the scope of section 4.02, paragraph (10) of Rev. Proc. 94-68, 1994-2 C.B. 803, and as such do not constitute examinations, inspections, or reopenings.

  5. The adjustments and penalties are reported on Form 4549-E, Income Tax Discrepancy Adjustments. Refer to IRM 4.75.15 line item instructions for completing Form 4549 which is substantially the same as for Form 4549-E.

    Note:

    See IRM 20.1, Penalty, for detailed information concerning penalty considerations.

4.75.28.1.1  (03-01-2003)
Referrals to Other Operating Divisions

  1. The discrepancy adjustment program does not entirely preclude examiners from making referrals to one of the other operating divisions.

  2. The examiner must prepare a referral on Form 5666, TE/GE Referral Information Report, for income tax adjustments otherwise treated as discrepancy adjustments when the related income tax return:

    1. Is a Form 1120-S, U.S. Corporation Tax Return for an S-Corporation;

    2. Is a Form 1065, U.S. Partnership Return of Income;

    3. Shows a net operating loss;

    4. Was filed by a taxpayer that has filed for bankruptcy;

    5. Was filed by a taxpayer that was dissolved, merged or sold;

    6. Is under the jurisdiction of LMSB - International;

    7. Is under the jurisdiction of LMSB as a Coordinated Industry Case;

    8. Was never filed; or

    9. Is currently under examination by another operating division.

      Exception:

      Situations described in (a) through (d) above may be processed as discrepancy adjustment cases by examiners with the concurrence of the Director, EO Examinations. If the Director, EO Examinations, approves the exception, the concurrence of the affected operating division Director will be requested before the discrepancy adjustment is processed.

  3. The examiner should consider the preparation of a referral to another operating division on Form 5666, TE/GE Referral Information Report, if:

    • The discrepancy adjustment involves complex income tax returns, or

    • A more detailed inspection of the taxpayer's books and records is necessary to resolve an income tax issue.

4.75.28.1.2  (03-01-2003)
Examination Activities by Other Operating Divisions

  1. If the examiner finds a potential discrepancy adjustment on a return that:

    1. Is currently under examination by another operating division, the discrepancy issue will be referred to the other operating division;

    2. Is assigned to another operating division but is in an inactive status, the examiner will contact the other operating division and have the return assigned for examination by that operating division as soon as possible;

    3. Has been examined and closed by another operating division, the examiner will process the discrepancy adjustment provided that case was not previously closed after consideration by Appeals Offices or District Counsels.

    Note:

    The income tax return must be closed off of the other operating division’s AIMS before it can be established on AIMS as a discrepancy adjustment. Although it can take up to 365 days to drop off of the other operating division’s AIMS from the time the case is closed by the other office, the return may still be secured. It may, however, be preferable for the examiner to secure an amended return.

4.75.28.2  (03-01-2003)
Identifying Discrepancy Adjustments

  1. The examiner is responsible for identifying the discrepancy during the course of the examination.

  2. The following are some examples of discrepancy adjustments that may result from an examination of an EO return:

    1. Compensation to employees not included on Form W-2 or Form 1099;

    2. Payments to an independent contractor, for services rendered, which were not reported on a Form 1099;

    3. Capital gains or interest to a seller when an exempt organization purchases real property;

    4. Adjustments to the return of a taxable subsidiary of an exempt organization.

4.75.28.3  (03-01-2003)
Processing Discrepancy Adjustments

  1. The examiner is responsible for initiating the discrepancy adjustment process and must be satisfied that the correct amount of income has been reported on the related income tax return.

  2. Discrepancy adjustments are controlled and processed within Exempt Organizations using AIMS, BMF, and IMF systems.

  3. The project codes for discrepancy adjustments for the related income tax returns are the same as those for the related EO return. The source code is always 87.

  4. Refer to IRM 25.6, Statute of Limitations for detailed instructions on income tax return statutes.

    Note:

    Restricted consents should rarely be accepted on discrepancy adjustment cases. See IRM 25.6 for the limited circumstances when restricted consents may apply and for special procedures to be followed.

  5. Any notices including, but not limited to, letters and a notice of deficiency shall be sent to each spouse. If the husband and wife live at the same address, the notice shall be sent to each spouse in a separate envelope, in accordance with the rules under IRC § 6015. Refer to IRM 4.75.28.3.3, Relief from Joint & Several Liability for detailed instructions.

  6. A RTVUE or BRTVU print will be accepted as the equivalent of a tax return if it provides sufficient detail to determine if there is a discrepancy, or if it gives sufficient line item detail to compute 1040 or 1120 income taxes. For unagreed cases, the EO Mandatory Review staff will obtain the original return before the case is sent to the tax court or appeals.

4.75.28.3.1  (03-01-2003)
Case Processing Instructions

  1. If a discrepancy adjustment is warranted, the tax return will be established on AIMS with Form 5597, TE/GE IMF/BMF/EPMF Request, and except as otherwise provided in item (2) below, a 30-day letter and a discrepancy adjustment report will be mailed to the taxpayer by certified mail.

  2. The discrepancy adjustment report package consists of the following:

    1. 30-day letter (Letter 3605);

    2. Form 4549-E, Income Tax Discrepancy Adjustments (two copies);

    3. An explanation of the issues for which discrepancy adjustments are being proposed;

    4. Publication 3498, The Examination Process;

      Note:

      The Publication 3498 is used in lieu of Publication 1, Your Rights as a Taxpayer, and Publication 594, What You Should Know About The IRS Collection Process, as an enclosure to the discrepancy adjustment 30-day letter. If the examiner does not have access to a current version of the 30-day letter listing Publication 3498 as an enclosure, Publications 1 and 594 can be used.

    5. Publication 5, Your Appeal Rights and How To Prepare a Protest If You Don’t Agree;

    6. Publication 556, Examination of Returns, Appeal Rights, and Claims for Refund;

    7. Publication 504, Divorced or Separated Individuals and Publication 971, Innocent Spouse Relief, if the adjustment is to a Form 1040, individual income tax return.

    Note:

    If prior to issuance of a 30-day letter, a signed Form 4549-E is secured from the taxpayer or the taxpayer's representative under Form 2848, it is not necessary to issue a 30-day letter or Publication 3498, however, Publication 1 must be issued in these cases.

  3. If the taxpayer provides additional information during the 30-day period, the examiner will consider the effect of the information received on the proposed discrepancy adjustment and:

    IF the additional information submitted THEN the examiner will issue letter
    Shows that no adjustment is necessary 3604 and close as a "no change" case.
    Changes the discrepancy amount or penalties, 3619 with a revised report
    Does not change the original report 3603 along with a copy of the report.
    Contains income tax records or other information requiring further development The examiner should make a referral on Form 5666 to the appropriate operating division for examination.

  4. If the taxpayer files a protest which does not change the report, the examiner will:

    1. Verify the protest is complete.

      Note:

      See IRM 4.75.20, Final Case Processing, for detailed information concerning verifying the completeness of a protest.

      ;

    2. If necessary, prepare a memorandum to Appeals with a brief response to the protest. Place the memorandum in the case file and provide a copy to the taxpayer;

      Caution:

      The memorandum must be shared with the taxpayer. Failure to do so will result in a prohibited ex parte communication. See IRM 4.70.2, TEGE Examinations - TEGE Communications with Appeals.

    3. Close the case to EO Mandatory Review Staff.

  5. If the taxpayer files a protest and the protest:

    Shows The examiner will issue letter
    The proposed adjustment is not appropriate 3604 and close as a "no change" case.
    Changes should be made to the proposed discrepancy amount or penalties 3619 with a revised report.

  6. If the taxpayer does not protest within the 30-day period, but previously indicated his/her intention to do so, the examiner will issue Letter 923(DO) which grants an additional 15 days to respond.

  7. If the 30-Day Letter is returned as undeliverable to the address on file, then an attempt will be made to obtain the correct address.

    1. If the taxpayer's correct address is determined, the 30-Day Letter will be re-mailed to the new address. The period in which the taxpayer may reply starts with the date the letter was re-mailed.

    2. If the taxpayer's correct address cannot be determined, the case will be closed unagreed to the EO Mandatory Review Staff.

  8. If the taxpayer neither agrees nor protests within the 30-day period, the case will be closed to the EO Mandatory Review Staff for issuance of a statutory notice of deficiency.

  9. If the taxpayer (and spouse, if a jointly filed Form 1040) or the POA agrees to the discrepancy adjustment by signing and dating the Form 4549-E, the examiner will close the case under the agreed case closing procedures in IRM 4.75.16, Case Closing Procedures.

4.75.28.3.2  (03-01-2003)
Special Processing Instructions

  1. If the total discrepancy adjustment to one taxpayer results in an overassessment, or an agreed but unpaid deficiency, of $50,000 or more, the case must be processed within 22 calendar days (16 business days) after the agreement is filed or the overassessment is determined. See section 3103 of the IRS Restructuring and Reform Act of 1998 (RRA '98).

  2. The examiner will close the discrepancy adjustment cases with the related EO case, unless:

    1. The discrepancy adjustment case must be closed before the related EO case due to statutory period of limitations considerations, or

    2. The discrepancy adjustment case must be closed within 22 calendar days and the EO case cannot be closed within this time period.

  3. The examiner should include copies of all materials from the related EO file which are necessary to document the discrepancy that gave rise to the adjustment.

  4. Partially agreed discrepancy adjustments should be processed in accordance with IRM 4.75.15, Report Writing and IRM 4.75.16, Case Closing Procedures.

  5. If a case is unagreed due to lack of response to Form 4549-E, the case will be closed to Mandatory Review staff to issue a Notice of Deficiency, Letter 531 (DO).

  6. If a discrepancy adjustment(s) is a result of an unagreed EO issue on the primary return, e.g., revocation or modification, the 30-day letter(s) and the discrepancy adjustment report(s) will be issued by the Mandatory Review staff at the same time the 30-day letter is issued on the primary return. The group should close the discrepancy adjustment(s) to Mandatory Review before Letter 3605 is issued. The primary return and the discrepancy adjustment(s) should be closed to Mandatory Review at the same time.

4.75.28.3.3  (03-01-2003)
Relief from Joint & Several Liability

  1. If a discrepancy adjustment is warranted with respect to a joint return under IRC § 6015, the following procedures should be followed:

    1. The last known address for each spouse should be verified. The current address for each spouse should be confirmed by researching IDRS and the Master File should be updated if the address has changed. For detailed procedures on locating taxpayers and what constitutes proper notice, see IRM 7.75.10.

    2. A copy of the discrepancy adjustment report should be sent separately to each spouse, even if they live at the same address.

    3. In the case of multiple year adjustments where the taxpayers filed a joint return in one year and separate returns in the other, the examiner will issue separate reports which must be mailed separately to each spouse, and must only contain information pertinent to the appropriate taxpayer.

  2. If Form 8857, Request for Innocent Spouse Relief, under IRC § 6015, or a statement containing substantially the same information signed under penalty of perjury is submitted, and the case is closed, the receipt date will be stamped on such Request for Innocent Spouse Relief, and it shall be sent to:

    Internal Revenue Service
    CSC, Stop 829, Unit 11
    201 West Rivercenter Boulevard
    Covington KY 41019

4.75.28.3.4  (03-01-2003)
Claims

  1. If a taxpayer files a formal claim with a service center on Form 843, Claim for Refund and Request for Rebate, Form 1040X, Amended U.S. Individual Income Tax Return, or Form 1120X, Amended U.S. Corporation Income Tax Return, while the income tax return is open on AIMS in an EO office, the service center will forward the claim to the examiner for action.

    1. On receiving a formal or informal claim, the examiner will contact the EO Classification office.

    2. The examiner will either be given assistance in ruling on the claim or will be instructed to transfer the claim to the appropriate operating division for examination.

  2. If EO retains jurisdiction over the claim and the discrepancy adjustment is open, the disposition of the claim must be described in the " Other Information" section of Form 4549-E. See IRM 4.75.15 which provides specific guidance on statements used to describe the disposition of claims. Since discrepancy adjustments do not constitute an "examination " the statements describing disposition of the claims should not make any reference to an "examination."

    1. If the claim is fully or partially allowed, the claim description and amount allowed should be entered on the appropriate adjustment line of Form 4549-E.

    2. If a formal claim is fully or partially disallowed, the report shall also contain Form 2297, Waiver of Statutory Notification of Claim Disallowance.

  3. If a taxpayer who makes a credible claim that he or she is unable to manage his or her own affairs by reason of physical or mental impairment, requests additional time to file a claim under IRC § 6511(h), the matter should be referred to the appropriate operating division on Form 5666 TE/GE Information Referral.

Exhibit 4.75.28-1  (03-01-2003)
Discrepancy Adjustment Letters and Forms

Old Number New Number  
LETTER/FORM TITLE
F 4549-E F 4549-E Income Tax Discrepancy Adjustments
L 2652P L 3605 Initial 30 Day Discrepancy Adjustment
L 923(DO) L 923(DO) Letter Extending Time to File Protest
L 2656P L 3604 No Change Letter - Follow-up to 30 Day Letter
L 2657P L 3619 Revised Report - Follow-up 30 Day Letter
L 2658P L 3603 Follow-up Response to 30 Day Letter - No Change to Initial Proposal
L 531 (DO) L 531 (DO) Notice of Deficiency

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