Before meeting with taxpayers and their professional representatives, IRS examiners usually do their homework. This includes reviewing any relevant Audit Techniques Guides (ATGs) that typically focus on a specific industry or audit-prone business transaction.
ATGs are available to the public even though they are designed to help IRS examiners prepare for audits. So, small business taxpayers can review them as well and gain valuable insights into issues that might surface during audits.
IRS examiners in the past were randomly assigned to audit taxpayers from all walks of life, with no real continuity or common thread. Therefore, there was little chance to develop expertise within a particular niche. For example, after an examiner audited a convenience store owner, the next assignment he or she received might have been a fishing boat captain or a dentist.
During the 1990s, the IRS created its Market Segment Specialization Program (MSSP) to remedy this, and the program expanded rapidly. The MSSP allowed IRS auditors to focus on specific sectors. Examiners became better equipped to identify and detect noncompliance with the tax code through education and experience.
The IRS started publishing ATGs as an offshoot of the MSSP. Most ATGs target major industries, such as construction, manufacturing and professional practices (including physicians, attorneys and accountants). Other ATGs address issues that frequently arise in audits, such as executive compensation and fringe benefits.
Periodically, the IRS revises and updates the ATGs and adds new ones to the list.
A Closer Look at ATGs
What does an ATG cover? The IRS compiles information obtained from past examinations of taxpayers and publishes its findings in ATGs. Typically, these publications explain:
- The nature of the industry or issue,
- Accounting methods commonly used in an industry,
- Common and industry-specific compliance issues,
- Business practices,
- Relevant audit examination techniques,
- Industry terminology, and
- Sample interview questions.
Since the main goal of ATGs is to improve examiner proficiency, by using a specific ATG, an examiner will, for example, be able to reconcile discrepancies when reported income or expenses aren’t consistent with what’s normal for the industry or to identify anomalies within the geographic area in which the taxpayer resides. Also, the guides help examiners plan their audit strategies and streamline the audit process.
Over time, the information and experience gained about a particular market segment can help examiners conduct future audits with greater efficiency. Some of this information is incorporated into periodic ATG updates. Furthermore, IRS examiners are routinely advised about industry changes through trade publications, trade seminars and information sharing with other personnel.
Site Visits and Interviews
ATGs may be able to identify potential sources of income that could otherwise slip through the cracks. These guides also identify the types of documentation that taxpayers should provide and information that might be uncovered during a tour of the business premises.
For example, the ATG for the legal profession identifies revenue streams derived from outside the general practice, such as serving on a board of directors, speaking engagements, and book writing or editing. The guide encourages IRS examiners to inquire about potential revenue sources during the initial interview with the taxpayer.
Other issues that ATGs might instruct examiners to inquire about include:
- The sources of funds used to start the business,
- A list of suppliers and vendors,
- Internal controls (or lack of controls),
- The availability of business records,
- Names of individual(s) responsible for maintaining business records,
- Nature of business operations (for example, hours and days open),
- Names and responsibilities of employees,
- Names of individual(s) with control over inventory, and
- Personal expenses paid with business funds.
For example, one ATG focuses specifically on cash-intensive businesses, such as salons, liquor stores, check-cashing operations, gas stations, auto repair shops, restaurants and bars. It highlights the importance of reviewing cash receipts and cash register tapes for these types of businesses.
Cash-intensive businesses may be tempted to underreport their cash receipts, but in order to deter “skimming,” franchised operations may have internal controls in place. For instance, a franchisee may be required to purchase products or goods from the franchisor, which provides a paper trail that can be used to verify sales records.
Similarly, when auditing a liquor store owner, examiners are taught to search for off-book wholesalers and check cashers. For gas stations, examiners must check the methods of determining income, rebates and other incentives. Restaurants and bars should be asked about net profits compared to the industry average, spillage, pouring averages and tipping.
ATGs are instrumental to the audit process, and allow IRS examiners to focus on those aspects that are unique to the industry, as well as ferreting out common means of hiding income and inflating deductions.
Although ATGs were created to benefit IRS employees, they also help small businesses ensure they aren’t engaging in practices that could raise red flags. To access the complete list of ATGs, visit the IRS website. And contact your tax advisor for more information on hot tax issues that may affect your business.