IRS instills new "LIFE" into its audits.

• Author: Dougherty, James A.
• Position: Limited Issue Focused Examination

In response to long cycle times, the need to expand audit coverage to other compliance risk areas, and limited resources, the Internal Revenue Service recently implemented a new process known as Limited Issue Focused Examination (LIFE). LIFE is a streamlined, focused examination process, which utilizes a risk-based methodology and materiality thresholds to limit the scope of IRS examinations. Both parties must enter into a formal agreement to participate in the process. LIFE is currently only available to Large and Mid-Size Business (LMSB) taxpayers (taxpayers with assets greater than $10 million). The taxpayer, revenue agent (with team manager's approval), or the team manager may suggest utilizing LIFE for the audit. The introduction of LIFE in the audit process should decrease cycle time and reduce the cost and burden to both the taxpayer and the IRS.

Summary of LIFE Initiative

LIFE utilizes a risk-based methodology in determining which issues will be examined during the audit. This approach allows both the IRS and the taxpayer to focus on the most significant issues on the return. At the beginning of an audit, the examiner will perform a full risk analysis of the taxpayer. Based on this analysis, the examiner will limit the scope of the audit by focusing only on those issues with the greatest risk of non-compliance.

The risk analysis also contributes to the establishment of materiality thresholds. These thresholds further limit the scope of the examination. Other factors that are considered in determining the thresholds include: input from IRS specialists and the taxpayer, dollar amounts involved, timing (issues that affect a short time frame are less material than issues that affect a longer one), and whether the transaction creates a permanent or temporary difference. Usually, different thresholds are established for temporary versus permanent differences. New materiality thresholds are established for each cycle or tax year. Once established, the materiality thresholds must be disclosed to the taxpayer.

In general, taxpayers are not allowed to submit claims or affirmative issues below the materiality threshold. Likewise, issues whose dollar value is below the materiality threshold will generally not be examined. There are, however, some exceptions to this rule. Tax shelters, coordinated issues, fraudulent issues, and items contrary to public policy are not subject to the thresholds and will be examined even if they are below the...