Source: http://oicattorney.blogspot.com/2013/07/section-183-irs-audit-guide.html
Timestamp: 2017-06-24 18:52:23
Document Index: 204965283

Matched Legal Cases: ['§ 183', '§ 183', '§ 7701', '§ 7701', '§ 183', '§ 183']

IRS Tax Attorney: Section 183 - IRS audit guide
Tax YearGain or (Loss)
An IRC § 183 issue will not be sustained in Appeals or in the courts if it has not been properly developed and documented.Included below are examination techniques specific to the IRC § 183 issue. Some of these techniques are the same or similar to techniques performed on a typical case.
FishingHorse RacingHorse Breeding
FarmingMotorcross RacingAuto Racing
Craft SalesBowlingStamp Collecting
Dog BreedingYacht CharterArtists
GamblingFishingBowling
Direct SalesPhotographyWriting
EntertainersAirplane CharterRentals
ExpenseAmountCategory 1Category 2Category 3
Step 1 – Remove Income from Schedule CThe first step in RGS is to remove the Schedule C income. Enter $3,000 in the Per Return field Enter zero in the Per Exam field. For the NAICS code enter “D” in the Per Exam field (the Schedule C is disallowed in full).
Step 2 – Add an issue for Other Income – UnearnedAdd an issue as a New Issue Resulting from a Classified Issue. Categorize the adjustment as Other Income – unearned (this income is not subject to self employment tax). Enter zero in the Per Return field. Enter $3,000 in the Per Exam Field.
Step 3 – Remove All Schedule C ExpensesIn the example, all Schedule C expenses have been classified. Disallow the Category 1 expenses in full by entering zero in the Per Exam field. Use Reason code 10 or 14 only if the item is allowed in full elsewhere on the return. Enter “D” in the NAICS code Per Exam field. Note that if these issues had not been classified the examiner would need to add each individual expense item as a separate adjustment into RGS.
Step 4 –Allow Category 1 Expenses on Schedule ACategory 1 expenses are allowable in full on Schedule A without regard to gross income limitations. Add each issue as a New Issue Resulting from a Classified Issue. In this example there are two separate adjustments – one to mortgage interest and one to real estate taxes. Use Reason Code 10 or 14.
Step 5 – Allow Category 2 and 3 Expenses on Schedule AThe remaining allowable expenses ($3,000 income less $1,600 category 1 expenses) are limited to the remaining income from the activity and entered as Schedule A Miscellaneous Itemized Deductions subject to 2% of AGI. One adjustment can be made for the combined expenses. In this example, the taxpayer will have $1,400 of Category 2 expenses. There is no remaining income with which to offset Category 3 expenses.
When proposing audit adjustments, penalties should always be considered. All penalties including the accuracy-related and fraud penalties are importantdeterrents to non-compliance.
Prior to May 25, 2007, IRC § 7701(a)(36) defined income tax return preparer as any person who prepared for compensation, or employs one or more persons to prepare for compensation, an income tax return or claim for refund, or a substantial portion of an income tax return or claim for refunded. After May 24, 2007, IRC§ 7701(a)(36) defined tax return preparer as any person that preparedfor compensation, or employs one or more persons to prepare for compensation, a tax return or claim for refund, or a substantial portion of a tax return or claim for refund, and is no longer limited to persons who prepare income tax returns.
Prior to May 25, 2007After May 24, 2007After Oct. 2, 2008
Penalty $250Penalty greater of $1,000 or 50% of the income derived by the preparer.Penalty greater of $1,000 or 50% of the income derived by the preparer.
Depreciation and Inventory can be viable issues for the examiner to consider as an aside from IRC § 183. The examiner should develop a clear understandingof the taxpayer’s activity and verify that the proper tax treatment is used for the activity.
Factor 4 hinges on whether the operation of the taxpayer’s activity and the holding of the land are considered to be a separate or single activity.According to the Treasury Regulations, Factor 4 states that the term “profit” also includes the appreciation of assets, such as land, used in the activity. An overall profit may occur, in spite of losses from current operations, if the appreciation of the assets is realized.
As previously mentioned, taxpayers can frequently show potential appreciation of asset value, usually with respect to the land. However, the appreciation of the assets may only be used as a consideration for overall profitably if the operation of the activity and the holding of the assets are considered to be a single activity.If the operation of the activity and the holding of the assets are considered to be separate activities, then the appreciation of the assets will not be considered for overall profit. In other words, if the operation of the activity and the holding of the assets are considered to be separate activities, the history of operational losses cannot be offset by the potential gain from asset appreciation.
The examiner should consider the potential for appreciation of the activity assets, especially the land. This information can be gathered from comparables.Comparables would show land values for properties similar to the taxpayer’s parcel. Comparables can be obtained from area realtors. Comparables are extremely important in determining land valuation. The potential for asset appreciation should be documented on a separate workpaper in the examiner’s case file.
The examiner will prepare a worksheet that details the history of other activities.This detail should show the profits and losses derived from the activities. In general, many taxpayers have achieved financial success in other business endeavors and yet failed in the operation of the activity in question.
A Schedule C for a dog breeding activity contained gross receipts for $3,200.Upon further development, the examiner discovered that the entire amount of the gross receipts pertained to a separate activity, other than the dog breeding.The examiner did not include the $3,200 of misplaced gross receipts in any worksheets during the development of the IRC § 183 issue. The examiner did incorporate footnotes that disclosed that $3,200 of gross receipts was erroneously reported on the Schedule C.
YearXXXX12XXXX12XXXX12XXXX12XXXX12
Gross Income Expenses (Other than Depreciation) Depreciation (Losses) or Gains Is there a trend toward profitability?
Did the taxpayer change operating methods, adopt new techniques, or abandon nonprofitable methods in a manner consistent with intent toimprove profitability.
Tax PeriodTax With LossTax Without LossTax Savings
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Totals Appendix D - Comparative Analysis Income, Expense and Losses
Income Gross Receipts Cost of Goods Sold Gross Profit Other Income Gross Income Expenses Advertising Car and Truck Commissions and Fees Contract Labor Depletion Deprecation Employee Benefit Programs Insurance (Other than Health) Interest Legal and Professional Office Expense Pension and Profit Sharing Plans Rent or Lease Repairs and Maintenance Supplies Taxes and Licenses Travel, Meals, and Entertainment Utilities Wages Other Expenses Office in Home Expenses Total Expenses Gross Income Less Expenses Appendix E - Example of an IDR for a Yacht Charter Activity
Copies of experience profiles submitted by potential charterers.Note to examiner: Is this a crewed charter where the yacht comes with a permanent captain and cook? Or, is this a bareboat charter where the charterer captains the yacht himself?
Insurance policy(s) on yacht and its contents (collision and liability).Note to examiner: Does policy cover rental of boat? Is it a commercial or personal asset?
Copy of First Preferred Ship Mortgage.Note to examiner: The Preferred Ship Mortgage provides the financer of a vessel competitive status among competing claims that might arise against a vessel. The lender of an ocean vessel, if eligible, secures a loan with a Preferred Ship Mortgage. Otherwise, in a foreclosure situation the lender will be ranked first among the various maritime creditors that may be competing to collect on a vessel’s proceeds.
Copy of commercial captain’s license.Note to examiner: Is potential charterer required to provide taxpayer a copy of their captain’s license?