Overview of IRS FET Tax Audits
Shortly after Tax Day 2016, IRS Commissioner John Koskinen remarked that, after five years of budget cuts and four years of hiring freezes, the agency would “do less with less.” The pronouncement is a mixed bag for those who must pay the federal excise tax on large trucks. While the agency may not launch as many FET audits as it did previously, it will be very aggressive in the ones it undertakes, and they may be conducted in summary fashion. That adds up to a “shoot first and ask questions later” mentality.
While every audit is obviously different, there are a lot of similarities to analyze, making it somewhat easier to defend these audits.
FET Audits: The Beginning
Industries with a high proportion of cash customers, such as marijuana retailers and some restaurants, are often on the informal IRS non-compliant industries list. So, owner-operators and shipping companies that work with these industries may wind up on the naughty list.
Large deductions and large losses on a 1040 might also draw unwanted scrutiny.
FET audits themselves normally begin with expansive IDRs (information document requests) and a taxpayer/corporate entity questionnaire that is almost mind-numbing in its amount of detail. Essentially, the IRS wants to collect as much information as possible with as little effort as possible. That’s not always a bad thing, as auditors may tip their hands in these document requests. Typically, these requests also indicate the nature of the audit (lottery, special project, referral, or whatever).
The Next Step
If at all possible, it’s important to limit the socpe of the audit to specific tax years and specific issues (i.e. income or FET taxes). Sometimes, there is some give and take. For example, agents are often willing to compromise in some areas of FET audits if the taxpayer agrees to file Form 872-B (waiver of the statute of limitations on past-due excise taxes), especially if the SOL may be an issue.
Typically, after the FET audits are well underway, the auditor sends the taxpayer a 30-day letter. After that time period, if there are no meritorious objections or responses, the IRS will asses the debt.
At that point, the taxpayer can essentially elect to either work out something with the auditor in terms of a payment schedule, or challenge the underlying issues in tax court. Obviously, much depends on the strength of the IRS evidence and the taxpayer’s appetite for risk. Simple and straightforward matters are usually more difficult to litigate than complicated, multi-issue FET audits.
In excise tax cases, the taxpayer must generally pay the assessed tax and then challenge the matter in either the Court of Claims or U.S. district court.
Some Common Issues in FET Audits
These audits often end up in court, because unlike income tax matters, FET audits often involve a number of highly complex, industry-specific issues, including:
- Active/Passive Losses: The distinction between active financial activity and passive activity (such as leasing) is typically a significant one, because the allowable deductions for passive losses are much lower.
- Hobby Losses: Though it’s harder to do with large trucks than with aircraft, the IRS often tries to classify small operators as hobbyists, thus limiting allowable losses.
- Non-Profit Engagment: The IRS will latch onto any use of a truck for instructional or other non-shipping purposes as a way to eliminate any claimed deductions.
Most civil matters, including most tax matters, settle out of court. Such settlement often occurs in medication or some other form of alternative dispute resolution.