The revenue agent's report and Form 4549: what the audit report contains and how to respond

What the report is for

IRM 4.10.8.2.1 gives the report three jobs. It protects the taxpayer's right to be informed, so it should show every adjustment and the tax, interest, additions and penalties. It is the basis for assessment and collection: “Reports (unlike workpapers) are legally binding documents.” And it gives notice of the liability for the interest suspension rule in IRC 6404(g), under which a Form 4549 with an explanation of each adjustment is sufficient notice. That last point matters to interest computations: a report without explanations may not stop the suspension clock. See interest abatement.

The report form depends on the outcome: no change, regular agreed, excepted agreed, partially agreed or unagreed. Each has its own procedure in IRM 4.10.8.

The report forms

Form 4549, Report of Income Tax Examination Changes, is the basic report for most individual and corporate income tax cases. Under IRM 4.10.8.2.2 it shows the adjustments to taxable income and the corrected tax, and has a signature line that waives the restrictions on assessment or accepts an overassessment. “By signing, the taxpayer is indicating they do not wish to exercise appeal rights with regard to the adjustments reflected in the report.” The report remains subject to review and acceptance by the area director or comparable manager.

Form 4549-A has no signature line. It is used for no-change, unagreed, excepted agreed, fully allowed claims and abatement cases. When it is used in an unagreed or partially agreed case, the examiner usually provides Form 870 so the taxpayer can consent to assessment. Office examiners can use Form 4549 instead of Form 4549-A and a waiver in unagreed cases.

An information-only report is a Form 4549 that does not propose a change, labeled “FOR INFORMATION ONLY,” usually prepared for offers in compromise. Partnerships under the centralized audit regime do not use these forms; see the BBA examination process. In LB&I cases, adjustments are first proposed issue by issue on Form 5701 before the report; see LB&I examinations.

What a complete report contains

IRM 4.10.8.2.2 lists the elements of a complete report:

1. A report form summarizing the findings and proposed adjustments (Form 4549, 4549-A or 4605).
2. Supporting schedules or explanations that show how each adjustment and the tax were computed: issue lead sheets for primary and alternative positions (without audit steps), standard explanation paragraphs and computation schedules generated by Report Generation Software.
3. Other required forms, such as the civil penalty approval form required by IRM 4.10.6.

Reports are generated in Report Generation Software (RGS), which inserts the nationally approved standard explanations. The examiner's activity record should show the date of each report, how it was delivered, to whom, and what was enclosed. If a report arrives without explanations for an adjustment, or without the penalty computation, ask for them; they are required parts of the report.

How adjustments are explained

Office examination reports usually use the standard explanations in IRM 4.10.10. Field examination reports attach a copy of the examiner's lead sheet for each issue, edited to remove audit steps, in a set format (IRM 4.10.8.12.4):

The facts section is the one to read hardest. The IRM requires facts favorable to the taxpayer to be included. If they are missing, say so in writing before the case closes; the lead sheet becomes the foundation for any rebuttal the examiner writes to a protest and for what Appeals sees first.

Watch for alternative positions. Under IRM 4.10.8.12.5, an alternative is a secondary position the IRS can rely on if the primary one fails, and “All alternative positions must be addressed or Appeals will not raise them” if the primary position is not sustained. Alternative positions must be discussed with the taxpayer before the report is issued. Common pairings in the IRM: IRC 183 with IRC 162 adjustments in the alternative; the fraud penalty with the accuracy-related penalty; disallowed unsubstantiated payments to individuals with backup withholding where Forms 1099 were not filed or TINs were not obtained. Penalties proposed in the alternative need the same timely written supervisory approval as primary ones; see supervisory approval under IRC 6751(b).

How the report is issued

Examiners are expected to discuss proposed adjustments, including penalties, in person before a report is mailed (IRM 4.10.8.2.3 and 4.10.7.5.1). If penalty approval is still pending, the examiner can share Form 5278 or a written list to discuss, but the report waits for the approval. “Written supervisory approval of penalties proposed subject to IRC 6751(b) must be obtained timely or the related penalties cannot be asserted.” Before issuing, the examiner checks the CAF for a new Form 2848 or 8821 and sends the representative a copy with Letter 937. Joint filers may get separate copies.

A 30-day letter must enclose the complete report, the waiver when required, and Pub 3498. IRM 4.10.8.12.1 adds: “Pub 3498 must always be enclosed with a 30-day letter even if it was provided with a previous report or letter.” Group managers sign 30-day letters. In the campus, the equivalent is Letter 525.

Reviewing the report

A practical review covers five things:

1. Arithmetic and carryovers. Recompute each adjustment and the tax, including self-employment tax, credits phased out by the new income, net operating loss effects and the qualified business income deduction.
2. Facts. Compare the facts section of each lead sheet to the record; list omitted favorable facts.
3. Law and alternatives. Check that the cited authority supports the conclusion and identify any alternative positions you will need to answer.
4. Penalties. Confirm the penalty basis is explained and ask when written supervisory approval was obtained.
5. Statute and dates. Note the response date, the ASED, and whether 365 days will remain when the case would reach Appeals.

Responding: time, new facts, corrections

Extensions

IRM 4.10.8.12.8 starts with a caution: “In general, Statement of Procedural Rules 601.105(d)(1) does not provide for an extension of time to reply to a 30-day letter.” As a practice, extensions are granted for reasonable circumstances, such as a newly retained representative, illness, or complex issues needing research. Ask in writing, give the reason, and expect a group manager decision confirmed on Letter 686. Extensions are normally no more than 30 days. If fewer than 240 days remain on the statute, an extension depends on a statute extension.

New information

Under IRM 4.10.8.12.9.1, the examiner evaluates information received after the 30-day letter. If it does not change the report, or reduces it without raising new issues, the examiner asks for agreement with Letter 692 (or 692-A or 692-B) and allows 15 days; no new 30-day letter is needed. If it raises a new issue or increases the deficiency, a new 30-day letter is issued, if the statute allows.

Corrected reports

A report revised after the 30-day letter or after signature is a corrected report (IRM 4.10.8.13). An error in the taxpayer's favor gets a corrected report with no new signature. An error against the taxpayer within the IRS error tolerance is processed at the signed amount; outside tolerance, the IRS prepares a corrected report and asks for a new signature, and if the taxpayer will not sign, partially agreed procedures apply. Each year stands alone; corrections are not netted across years.

Agreeing, partly agreeing or protesting

To agree, the taxpayer signs the report or waiver; the consequences are covered in what signing Form 870 or 4549 means. A signature with added conditions is a problem: IRM 4.10.8.2.4.2 says “Conditional statements will invalidate an agreement or waiver.” To partly agree, sign a Form 870 for the agreed adjustments (see partial agreements and closing). To disagree, file a formal protest or, if no period exceeds $25,000, a small case request by the response date.

Questions practitioners ask