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Federal Fuel Tax Credit Subject to IRS Audit

Sep 29, 2017

In recent months, the IRS has been conducting “line item correspondence audits” of the fuel tax credit claimed by many farmers on their federal income tax return. 

The law provides for taxpayers engaged in the business of farming to claim a refund of the federal fuel tax they paid on fuels such as gasoline and clear diesel that the farmer used “off road” in the farming business. “Off road” is supposed to be interpreted to mean fuel used in connection with the farm operation but not while traveling on any public roads or highways. From a practical standpoint, most farmers don’t keep actual records of their “off road” use but rather provide their CPA with an estimate. 

The federal rule for refund of fuel tax should be differentiated from the rules provided by the State of Montana for refunds of state fuel taxes. The State provides for a simplified method of calculating its refund by merely claiming a refund of taxes paid on 60% of all gallons of taxed fuels purchased by the farmer. 

The IRS correspondence audits are proving to be difficult to resolve in taxpayers’ favor for a number of reasons:

  1. It is difficult, and sometimes not possible, to discuss the matter with an IRS auditor. They request documentation to be mailed back to the IRS and then seem to be issuing “final” audit adjustments by simply denying the entire credit. In most IRS audits, the taxpayer’s representative (CPA) has the opportunity to discuss the issues at hand with the IRS auditor. This provides a platform for dialog to explain the documentation and provide justification for any estimations that were made. This dialog often results in a positive result for the taxpayer. 
  2. The IRS seems to be operating under the belief that no credit is allowed if the fuels are burned in a vehicle that is even licensed for travel on public roads. This is a misinterpretation of the rules, which allow the credit for fuels consumed by farmers off road in the business of farming.
  3. The IRS is quick to push the audit to a level of issuing a “notice of statutory deficiency,” which can limit taxpayers’ recourse to filing a petition in U.S. Tax Court to defend their position. In one case, the IRS even skipped sending a written notice of adjustment that would allow the taxpayer to file a request for administrative appeal. 
  4. It seems as though the IRS has identified a relatively small item to audit and adjust, possibly with the hope that taxpayers will just give up and pay the credit back rather than fight for their position. 

We are working diligently to oppose the arbitrary and, in some cases, incorrect positions that the IRS is taking in these correspondence audits. If you have experienced a similar situation, we would be interested in knowing about it so we can evaluate whether actions can be taken to move the IRS in a more correct direction. If you have received one of these audit notifications, please be mindful of the time deadlines imposed by the audit process. If you miss a deadline, you could be limiting your rights to defend your position.