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Chapter 4 - Pre-Audit Analysis

Analysis of Information Accumulated Before Starting the Audit

Returns assigned to you will normally contain, at the most, charge-out labels, a transcript, and an IRP transcript. When you are assigned a reforestation contractor and the case file does not contain an IRP transcript, order one as soon as possible. You may find that the contractor has several sources of income that he or she has failed to report. However, do not use the IRP document as your only income probe since it is most likely that this document is only partially complete at best. Hopefully, the following discussion of the IRP transcript will give you a better understanding of the Form 1099 reporting problems of this industry.
IRP Transcripts

"Income" is the audit issue which benefits most from accumulating the types of information/documents that are discussed in this chapter. Most commonly, an examiner has little information in the file before the first appointment with the taxpayer. Items that have been accumulated at this stage of the audit are those that have been generated by the Service Center. Of these, only the IRP transcript has the potential of assisting in the income audit but, as known by most examiners, these documents rarely give a complete listing of an entity's taxable sources of income. However, the IRP transcripts are a good starting point in the income audit.

We found three major problems with how the Federal agencies were handling the filing of their Forms 1099. First, the Federal employees were not sure who should receive a Form 1099; one agency reported that they were not issuing Forms 1099 to partnerships. Secondly, the Federal agencies issuing the contracts were not assuming responsibility to see that a Form 1099 was issued. The Form 1099 was only issued if the proper box was indicated on the payment voucher by the individual requesting the payment. Finally, there was a question as to who was responsible for seeing that the taxpayer identification numbers (TIN's) were provided. According to the company who issued the check, if the identification number was not included on the payment voucher, then a Form 1099 would not be issued for that payment.

Whether or not the Forms 1099 are complete is only one of the problems. The second identified problem is whether or not the Form 1099 is correct. During our examination of one reforestation contractor, we found that he issued 35 Forms 1099. Of the Forms 1099 issued, we found that: 1) Nine Forms 1099 matched the name and SSN shown on AIMS and 2) 26 of the Forms 1099 had either the wrong SSN or no data was available on AIMS. The group researched Forms 1099 filed by two other contractors and found that some contractors appear to be filing erroneous Forms 1099 to circumvent the Form 1099 matching program.

Even though the Forms 1099 may not be 100 percent correct, they are very useful and may identify sources of income which cannot be found using other audit procedures. For example, a contractor's accountant did a bank deposit analysis to determine his income. The bank deposit analysis appeared to be complete and show all sources of income. However, after receiving an IRP transcript we were able to identify income received from unreported sources which were not deposited by the contractor.

Document Request

1. Request the normal documents

At a minimum, the following should be requested: All books and records, adjusting journal entries, accountant's workpapers, bank statements for business and personal accounts, savings account and credit line statements, duplicate deposit slips, a detailed depreciation schedule, Forms 1099 received, Forms W-2 and 1099 filed by the contractor, copies of employment tax returns (beginning with the year under audit to the most current returns filed), and copies of invoices retained.

2. Request additional documents

a. Request the prior and subsequent year returns. A comparative analysis is helpful in identifying large or unusual items.

b. Request a listing of all contracts worked by the taxpayer during the year and a listing of the contracts in progress at yearend.

c. Request a tour of the business. This may be the only time you will be able to inspect the business premise in order to determine if the assets claimed on the return exist and are reasonable.

d. Request that the initial interview be held when the taxpayer(s) can be present. The initial interview may be the only time that you will be able to talk to the taxpayer.

During your pre-audit you may find other items that appear to be unreasonable. Be sure to include these items on the document request. Remember that it is important to make the document request as complete as possible since it becomes increasingly harder to get documents as the audit progresses.

The contractor shall continue performance of the work according to the time specified within the Schedule of Items.

Failure to do so may be cause for action under the "Default" clause.

At the pre-work conference, the contractor shall provide to the COR a written "work progress plan" which details his or her work force and his or her proposed schedule for completion of the work, within the contract performance time. The work schedule will be used as a guide to measure the contractor's performance as well as to calculate such things as the rate of tree delivery to meet the contractor's needs to ensure the timely completion of the contract. If the contractor's progress falls behind 20 percent of the established work schedule, the contractor's right to proceed may be terminated for default unless satisfactory progress is attained within 3 working days of the receipt of the written notice of deficient performance.

The COR is the on-the-ground administrator for the Contract Official. The COR is authorized to clarify technical requirements, and to review and approve work within the scope of the performance of the contract. The COR has the authority to designate a Project Inspector to determine whether or not the contractor has complied with the technical specifications, drawings, work schedule, and labor provisions at the work site.

At the pre-work conference, the Contract Official or the COR will make sure that each contractor understands, among other things, that the individuals performing the work are employees and are governed by statutory and regulatory laws pertaining to the reforestation industry. Some Contract Officials or CORs will have a special checksheet for the pre-work conference; you will find a copy of an actual checksheet used by a Contract Official, see Exhibit 3-1. This checksheet may be helpful in convincing the prime contractor that his or her workers are employees and do not qualify as subcontractors. Please refer to the employee section for further discussion of employees and laws applicable to the reforestation industry.

Payments

All vendor payments of $25,000 or more must be made through the Treasury Financial Communication System (a wire transfer system). Beginning sometime after December 31, 1988, and before December 31, 1989, contractors successful in obtaining contracts were required to supply certain financial institution information, (bank account numbers), to the Federal Government so their contract payments could be deposited directly to their bank account.
Contractors normally receive more than one payment during the performance time of the contract. According to Contract Officials, the contractors are paid approximately every 2 weeks and the amount of the payment is based on the work done, determined by the percentage of completion. However, it takes approximately a month from the time the contractor begins work on a contract until he or she receives the first payment.
Keep in mind, the duration of a contract is relatively short. In other words, once the contract is awarded it is usually started within 2 to 3 weeks and completed within another 2 to 4 weeks, depending on the size of the job. The Forest Service keeps the duration of the contracts short since they are concerned about planting the trees at a time which will ensure the highest rate of survival among the new seedlings.
You may find that the contractor has deposited funds into his or her business account that he or she does not consider to be taxable. Reforestation contractors are able to secure advances from their bank by assigning the income from the contracts that they have been awarded. For a discussion on assignment of income see Chapter 6, of this audit guide.

Exhibit 3-1 - Checksheet Used by Contract Official [Exhibit omitted]