When an IRS Audit Expands to Other Years and Issues

Every audit starts with a defined scope: a return, a year, a few issues. Every audit can also grow. The IRM gives examiners real discretion here, but it also sets procedures, notice requirements and limits. Know them, and you can see expansion coming and sometimes prevent it.

Where scope starts

For most exams, the starting scope is set during classification. The IRM defines classification as determining whether a return should be audited, the initial issues to be audited and who should conduct the audit, and notes that the number of classified issues is typically limited to three (IRM 4.1.5.3, 4.1.5.3.2). Those are the items in your initial letter. See how returns are selected.

The IRM then gives the governing principle: examiners "should only work issues of merit and conclude the examination when the issues no longer warrant examination" (IRM 4.10.2.7.1). The goal is a "substantially correct" tax liability, not a perfect one (IRM 4.10.2.7.1.1).

Adding issues in the same year

The rules differ by type of exam (IRM 4.10.2.7.1.2):

• Office exams. Scope is documented on a classification check sheet, but it "should not be limited to the classified issues if other significant issues are revealed." The examiner must consult with and get approval from the group manager before declassifying issues or raising new ones.
• Field exams. The scope is determined by the revenue agent.

Either way, the examiner must document a change in scope, including how and when you were notified. And from the very first call, the IRM directs examiners to tell you the exam may be expanded to additional issues (IRM 4.10.2.8.2). Nobody should be surprised that it can happen. You can still ask why it is happening.

Some testing is always in scope. The IRM requires minimum income probes on every exam, even when income is not a listed issue (IRM 4.10.4.2). So questions about income are not an expansion; they are standard. See bank deposits analysis.

Adding prior and subsequent years

If the examiner expands to another tax period, IRM 4.10.2.7.1.2 says you must be notified orally or in writing, and the examiner should:

• Use Letter 5968, Prior or Subsequent Year Pickup, for written notice.
• Give you time to update your power of attorney if it does not cover the new years.
• Request records for the new years by IDR and allow time to produce them.

The IRS's own audit page sets expectations on how far back: generally it can include returns filed within the last three years, it may add years if it identifies a substantial error, and it usually does not go back more than the last six years.

The IRM also limits the income work in added years. When minimum income probes on the primary year found no income issues, the probe for prior or subsequent years can be limited to an information return analysis, if the examiner reviewed those returns for large, unusual or questionable income items (IRM 4.10.2.7.1.2).

Related returns

Expansion to a related return is the examiner's judgment. If required filing checks show you did not file a required return, or another filed return has audit potential, the examiner should expand if warranted (IRM 4.10.2.7.1.5). For office exams, that may mean reassigning the related return to a more experienced examiner or to field exam. Partnership returns follow their own procedures and approvals.

One useful IRM rule: when an examiner inspects a Schedule K-1 to check that flow-through items were reported correctly, the taxpayer should be told the inspection does not constitute an examination, and that distributions may be adjusted later if the entity is examined (IRM 4.10.2.7.1.3).

Expansion and your power of attorney

A Form 2848 covers only the tax matters and years listed on it. If the exam expands to a year your representative is not authorized for, the IRM directs the examiner to give you time to secure a power of attorney for the added periods (IRM 4.10.2.7.1.2). Use that time. Until the new form is on file, the examiner cannot discuss the added years with your representative, and you do not want to handle the new years alone by default.

Practical tip: when you first sign a Form 2848 for an audit, consider covering the years before and after the year under exam. It costs nothing and avoids a delay if the scope grows.

When a mail audit becomes an in-person audit

Expansion can also change the type of exam. The campus exam manual provides for transferring a correspondence exam to an area office when an issue is too complex for correspondence, with manager approval and enough time remaining on the statute (IRM 4.19.13.16). If your mail audit starts producing requests that read like a business audit, ask whether a transfer is being considered. See changing where your audit takes place.

The rules that limit scope

Expansion is not unlimited. The IRM provides several brakes.

• Risk analysis. Examiners are expected to prioritize issues with higher audit potential, and "issues with little or no audit potential should not be selected for examination" (IRM 4.10.2.7.1.1).
• The mid-audit decision point. At about the halfway mark, the examiner should decide whether the remaining issues are worth examining, for example when additional tax is not expected to be material (IRM 4.10.3.3.2).
• Information return cases. When a taxpayer is selected for an information return item, the scope is generally limited to resolving those differences, with emphasis on why the income was omitted and whether it happened in more than one year (IRM 4.10.2.7.1.3).
• Collectibility. Scope may be limited when the taxpayer has no ability to pay and no expectation of future ability (IRM 4.10.2.7.1.3).
• Recently no-changed issues. If the same issues were examined and no-changed, or resulted in a small change, in either of the two preceding years, they should be eliminated from the audit plan unless other information shows they are worth examining (IRM 4.10.2.7.1.4). See repetitive audits.

National Research Program exams follow a different rule: prior, subsequent and related returns are not required to be picked up, but the examiner may still expand using standard procedures (IRM 4.22.6.6). See NRP audits.

What usually triggers expansion

From the IRM's structure, the triggers are predictable:

1. An issue in the current year that is likely to recur, like a business expense pattern or an unreported income stream.
2. Income probes that show an imbalance.
3. Required filing checks that turn up a missing return.
4. Answers in the interview that open new questions.
5. Documents produced that were not requested and raise new items.

How to keep a narrow audit narrow

• Answer what is asked. Produce what the IDR requests, completely, and stop there. See answering a Form 4564.
• Resolve recurring issues cleanly. If the problem in the current year would exist in other years, consider whether correcting it yourself is better than waiting for a pickup.
• Prepare for the interview. Inconsistent answers about income or cash invite more years. See the initial interview.
• Ask about the basis for expansion. Respectfully. "What did you see that warrants adding the prior year?" is a fair question, and the answer tells you where to focus.
• Raise repetitive audit history early. If the same issue was no-changed in either of the two prior years, say so with the no-change letter in hand.

Scope expansion is not punishment. It is the examiner following the evidence. Give the examiner clean evidence on the issues in front of them, and there is usually less evidence leading anywhere else.