Chapter 2B.Tax Practice

C8-Chp-02B-1-Tax-Practice-2008

Howard Godfrey, Ph.D., CPAProfessor of Accounting

Copyright ©, Howard Godfrey, 2008

The student should be able to:1. Understand the requirements for

practicing before the Internal Revenue Service. Pg. 40.

2. Understand the process by which the IRS issues rulings in response to requests from taxpayers or IRS agents, and the use of those rulings. Pg. 41+.

3. Understand the types of IRS audits. Pg 44+.

4. Understand the appeals process, within the IRS and in the court system. Pg. 47+.

5. Understand the statute of limitations and how it affects audits and refunds. Pg. 53+

The student should be able to:6. Understand the most important penalties that

may apply to taxpayers, and how to compute them. Pg. 54+

7. Understand the penalty for underpayment estimated income tax. Pg. 58+.

8. Understand penalties that may apply to tax preparers, and how to compute them. (Please make a note to update your textbook and your codebook for changes made recently in code section 6694. See document below homework on web page) Pg. 59+.

9. Understand ethical requirements and professional responsibilities placed on CPAs by the IRS, the AICPA, and state boards of accountancy. Pg. 60+

Administrative Procedures (1 of 2)

• Role of the IRS

• Audits of tax returns

• Requests for rulings

• Due dates

• Failure-to-file/pay-penalties• Estimated taxes

Administrative Procedures (2 of 2)

•Severe penalties

•Statute of limitations

•Liability for tax

•Tax practice issues

1. Understand the role of the IRS in our tax system.

Role of the IRS

• Enforcement of tax laws

• Collection of taxes due

• Interpretation of Internal Revenue Code

Organization of the IRS Not on the test in this course

Commissioner/Deputy Commissioner

Shared Services Functional Units Operating Divisions

Agency Wide SharedServices 4,900 employees

Agency Wide Info SystemsServices 7,000 employees

Appeals1,900 employees

Taxpayer AdvocateService 1,600 employees

Criminal Investigation4,500 employees

Wage & InvestmentIncome 21,000 employees

Small Business & SE39,000 employees

Large & Mid-sizeBusiness 9,500 employees

Chief Council2,600 employees

National Office Staff1,000 employees

Tax Exempt & Gov’t Entities2,800 employees

2. Discuss how returns are selected for audit and the alternatives available to tax payers whose returns are audited.

Selecting Returns for Audit

• Information Document Matching Program

–Computerized matching of information on return with data from 3rd parties (W-2 from employer)

• Mathematical/Clerical Error Program

• Unallowable Items Program

Audits of Tax Returns (2 of 3)

• Returns selected for audit by discriminant function & other means–39% of returns selected by using

DIF–NRP exams less intrusive than

TCMP

Audits of Tax Returns (3 of 3)

• Types of audits–Correspondence audit–Office audit–Field audit

• Appeals process• Burden of proof

Types of Audits– Correspondence audit – verify one

or two items in question by mail– Office audit – requires some

analysis & IRS judgment through interview

– Field audit – typically limited to examination of business returns

– Large corporations provide office for IRS to audit year-round.

Appeals Process (1 of 3)

• Taxpayer first meets w/ revenue agent (and supervisor)

• If taxpayer disagrees w/ findings, IRS sends thirty-day letter

–Taxpayer has 30 days to request a conference w/ appeals officer

• Taxpayer meets with appeals officer

Appeals Process (2 of 3)

• If no agreement with appeals officer, IRS issues 90-day letter

–Taxpayer has 90 days to file petition w/ Tax Court or pay the tax

–Taxpayer must pay tax first to litigate in either District Court or U.S. Court of Federal Claims

Appeals Process (3 of 3) • Either party may appeal

court decision to Circuit Court–Usually final appeal as Supreme Court rarely hears tax cases

Burden of Proof (1 of 2) • In civil court cases burden of

proof on factual matters shifts to IRS if taxpayer does all of the following:–Introduces “credible evidence”–Complies w/ recordkeeping &

substantiation requirements of IRC

Sec. 7491

Burden of Proof (2 of 2)

• Burden of proof (continued)

–Cooperates w/ reasonable requests

–Qualifies as a natural person or legal person w/ net worth $7 million

Which of the following types of IRS audits involves the least extensive audit procedures?

a. Office audit

b. Field audit

c. Correspondence audit.

After an audit, a taxpayer who does not agree with the audit findings will receive a:

a. Letter Ruling

b. 30-day letter

c. 90-day letter

d. Revenue Ruling

The examination of Greta’s’ tax return for 2005 resulted in adjustments creating a tax liability in the amount of $30,000. Greta does not believe she owes anything. A Notice of Proposed Income Tax Deficiency is issued to Greta, who wants to appeal the Revenue Agent’s adjustments to the IRS Office of Appeals. Greta must file a written protest letter no later than which of the following periods?

a. 10 days. b. 30 days. c. 90 days.

d. 120 days e. None of these

If a taxpayer and IRS disagree about a proposed tax assessment after an Appeals conference, the taxpayer can take his case to the following court without first paying the tax:

a. United States Tax Court

b. United States Court of Federal Claims

c. United States District Court

d. Any of the above (IRS 1999) 

When the IRS and the taxpayer disagree about a proposed assessment at the conclusion of an audit, the taxpayer will receive:

a. A 30-day letter that gives the taxpayer 30 days to file a petition with the Tax Court.

b. A 30-day letter that gives the taxpayer 30 days to request a conference with an IRS Appeals Officer.

c. A 90-day letter that gives the taxpayer 90 days to file a petition with the Tax Court.  

d. A notice and demand that the tax liability is due and owing.

After the issuance of a Statutory Notice of Deficiency, failure to timely file a petition with Tax Court will result in which of the following?

a. The Internal Revenue Service will issue a 30-day letter.

b. The Internal Revenue Service will assess the tax it says the taxpayer owes. 

c. The Internal Revenue Service will issue a 90-day letter. IRS-2004 

[Sec. 6213(a), Sec. 7463] Nicholas wants his income tax case to be handled under the Tax Court’s “small tax case procedure.” All of the following statements regarding the “small tax case procedure” are correct except:

a. The amount in the case must be $50,000 or less for any one-tax year.

b. The amount does not need to be paid before going to Tax Court. 

c. The taxpayer must file a petition with the Tax Court within 90 days of the day on which a statutory notice of deficiency was mailed to the taxpayer. 

d. The decision can be appealed to the United States Court of Appeals.

In deciding whether to carry a case to the Tax Court or District Court, the following advantage of the District Court should be considered:

a. the IRS cannot appeal a District Court decision

b. payment of the tax deficiency before trial is not required in the District Court

c. a jury trial may be available in the District Court

d. in case of inadequate accounting records of the taxpayer's income,

e. the burden of proof will be on the IRS in the District Court

3. Describe the IRS's ruling process.

Requests for Rulings• Allows taxpayer to learn how

IRS will treat a particular transaction before the transaction is completed

• Request made in writing

• IRS has option whether or not to respond

A taxpayer who is uncertain about how a prospective future transaction should be reported may request from the IRS a:

a. Letter Ruling

b. Revenue Ruling

c. Regulation

4. Identify the due dates for tax returns and penalties associated with not abiding by such dates. Sec. 6075

Filing Deadlines• Returns for individuals, partnerships, estates,

and trusts due 15th day of 4th month (April 15)• Corporate returns due 15th day of 3rd month

(March 15)• Extensions of time to file

– Individuals: 6 months (new)– Corporations: 6 months

• Extensions for filing deadline available, but tax must be paid by original due date to avoid penalties

• Interest due on tax not timely paid

Filing DeadlinesBig Company, a corporate taxpayer, has a fiscal year ending October 30. The due date, excluding extension, for filing their return is:

a. January 15. b. November 15.

c. December 1. d. December 15.

(Sec. 6072, 6081, 6151)

5.Understand Tax Related penalties generally

Failure-to-File/Pay-Penalties

• Failure to file penalty

–5% per month or fraction thereof of net tax due w/ a 25% maximum

–Fraudulent failure to file is 15% per month or fraction thereof w/ maximum of 75%

• Failure to pay incurs a penalty of 0.5% per month up to 25%

Filing Penalties • Failure-to-pay penalty

– ½ percent for each month (or part of month) payment is late (maximum 25%)

• Failure-to-file penalty

– 5 percent per month (or partial month) return is late (maximum 25%)

• If both apply, rate is combined 5 percent for first 5 months and ½ percent thereafter (47½ percent maximum)

Filing Penalties• No failure-to-file penalty if no tax is

owed• Minimum $100 failure-to-file penalty if

return more than 60 days late• Fraudulent failure-to-file can increase

latefiling penalty to 15% a month (75% maximum)

• Installment agreement possible if unable to pay tax when due (late payment penalties apply)

6651(a) ADDITION TO THE TAX. -In case of failure-(1) to file any return … on the date prescribed therefor (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause …, there shall be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate:

6651(a) ADDITION TO THE TAX. -In case of failure –(2) to pay the amount shown as tax … on or before the date prescribed for payment of such tax (determined with regard to any extension …), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount shown as tax on such return 0.5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 0.5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate;

FINAL-REG §301.6651-1. Failure to file..(b) Month defined(1) If the date prescribed for filing the return or paying tax is the last day of a calendar month, each succeeding calendar month or fraction thereof during which the failure to file or pay tax continues shall constitute a month for purposes of section 6651.(2) If the date prescribed for filing the return or paying tax is a date other than the last day of a calendar month, the period which terminates with the date numerically corresponding thereto in the succeeding calendar month and each such successive period shall constitute a month for purposes of section 6651.

Filing PenaltiesTaxpayer filed 2005 tax return on May 5, 2006, without requesting an extension. What is the total amount of his failure to file and failure to pay penalties if his total tax is $10,000 and he paid $7,500 through timely withholding and $2,500 with return filed on May 5, 2005?a. $75.00 b. $125.00 c. $750.00 d. $375.00 e. None of these

Failure to File Penalty(5% for each monthor part of a a month)Tax liability 2,500$ Failure to File PenaltyAmount of Penalty

Failure to File Penalty(5% for each monthor part of a a month)Tax liability 2,500$ Failure to File Penalty 5%Amount of Penalty 125$

6.Calculate the penalty for not paying estimated taxes.

Estimated Taxes• Taxpayers receiving income other

than salaries & wages should pay quarterly estimated tax installments–Payments should equal lesser of

90% of tax due or 100% (110% if AGI > $150K) of last year’s tax

• Penalty for underpayment of ES taxes based on interest on underpayment times amount of time outstanding

Sec. 6654

Estimated Taxes• We won’t calculate the underpayment

penalty in class or on the test because that involves detailed “interest” type computations for the number of days of underpayment (late payment) for each quarterly payment.(Incidentally, quarterly payments are not quarterly: April 15, June 15, September 15, January 15)

Interest on Unpaid Taxes• We won’t calculate interest on

underpayments (late payments) in class or on the test because that involves detailed interest computations for the period of underpayment.

• Late payment interest applies to payments made after due date (generally April 15).

• Estimated tax penalties apply to period before due date of return.

[Sec. 6654(d)] A taxpayer had AGI of $98,000 and a total tax liability in 2005 of $20,000. In 2006, the taxpayer has a tax liability of $25,000. Withholding in 2006 $23,500. He will file his tax return for 2006 on April 10, 2007. To avoid the underpayment of estimated tax penalty for 2005, the taxpayer must:

a. Pay the additional $1,500 due by April 15, 2007.

b. Pay an additional $1,500 by January 15, 2007.  

c. File an annualized estimated tax computation.  

d. Do nothing, as he has satisfied the minimum tax payment requirements. IRS-2003 

[Sec. 6654(d)] Repeat the preceding slide. Suppose his total tax for 2005 was $40,000 and his 2006 tax liability will be $50,000. His withholding will be $23,500.

It is now November, 2006. Should she make estimated payments or increase withholding?

7. Describe more severe penalties, including the fraud penalty.

Severe Penalties• Penalty for underpayment due to

negligence or disregard of rules or regulations is 20% of underpayment

• Penalty for substantial understatement exceeding greater of 10% of tax liability or $5,000 ($10,000 for a C corp) is 20% of underpayment

Sec. 6662

Severe Penalties• Civil fraud

–IRS has burden of proof

–Systematic omission from gross income or fictitious deductions or dependency claims...

–Civil fraud penalty is 75% of portion of underpayment attributable to fraud

Sec. 6663

Severe Penalties•Criminal fraud

–IRS has burden of proof–Prosecution may result from willful attempts to evade any tax, willful failure to file or willfully making returns taxpayer does not believe to be true and correct ...–Maximum penalty is a fine of $100,000 ($500K for corp), 5 years in jail or both. –Sec. 7201

[Sec. 6663] Ron’s tax returns were examined for 2006, and the agent proposed adjustments increasing income reported on Schedule C of the returns. The agent determined that the failure to report the income was intentional. The agent proposed a fraud penalty. The adjustment for 2006 was in the amount of $100,000. The fraud penalty should be:a. $50,000 b. $75,000c. $18,800 d. $28,200 IRS-2002

8. Understand the statute of limitations.

Statute of Limitations

Tax Years

2010 20112007 2008 2009

File 2007 Return

April 15, 2008

Statute of Limitations (1 of 2)

• Normal time limit is three years from later of due date or date filed

• For substantial omissions, time limit is six years

• No statute of limitations for fraud

• No statute of limitations if a tax return is not filed

Statute of Limitations (2 of 2)

• Refund claims

– Taxpayer not entitled to refund for overpayments unless claim for refund filed by later of

• Three years from date original return is filed, OR

• Two years from date they pay tax[This protects you when the IRS assesses more taxes near end of SOL period.]

Statute of Limitations

• Period of time beyond which legal actions or changes to the tax return cannot be made by taxpayer or IRS

– 3 years from date of filing or due date of return (whichever is later)

– 6 years if more than 25% of gross income inadvertently omitted (not excess deductions)

– No time limit for fraudulent returns(Burden of Proof on IRS)

Statute of Limitations.Jennifer did not file a tax return for 2000 because she honestly believed that no tax was due. In 2007, the IRS audits Jennifer and the agent proposes a deficiency of $500.

What is the tax issue?

Statute of Limitations

Solution: Will Jennifer be required to pay the $500 deficiency?

Does the statute of limitations apply when no tax return is filed?

Statute of Limitations.

On his 2004 tax return, Stewart inadvertently overstates deductions in excess of 25 percent of the adjusted gross income on the return. In 2005, the IRS audits Steward and the agent proposes a deficiency of $1,000.

What is the issue?

Statute of Limitations.

Solution: Can the IRS collect the deficiency of $1,000?

Does the statute of limitations prohibit the assessment of the additional tax?

[Sec. 6502] Generally, the statute of limitations for the collection of income taxes is (Sec. 6502):

a. Three years after the due date of the return

b. Three years after the tax is assessed 

c. Ten years after the tax is assessed d. Ten years from the last day of the

tax period (calendar or fiscal) for which the return is filed IRS-2001 

[Pg. 26] [Sec. 6501] Jackson Corp., a calendar-year corporation, mailed its 2003 tax return to the Internal Revenue Service by certified mail on Friday, March 11, 2004. The return, postmarked March 11, 2004, was delivered to the Internal Revenue Service on March 14, 2004. The statute of limitations on Jackson's corporate tax return begins on:

a. December 31, 2004. b. March 11, 2004

c. March 15, 2004 d. March 14, 2004

CPA Nov. 1994 

[Sec. 6511] Joe, a calendar year taxpayer, filed his federal income tax return, with a refund due, for tax year 2006 on April 1, 2007.

he last day to timely file a claim for refund with respect to that return is:

a. April 1, 2009. b. April 15, 2009.

c. April 1, 2010. d. April 15, 2010.

[Sec. 6501(e)] Keen, a calendar‑year, individual taxpayer, reported a gross income of $100,000 on his 2005 income tax return. Keen inadvertently omitted from gross income was a $40,000 commission that should have been included in 2005. Keen filed his 2005 return on March 15, 2006. To collect the tax on the $40,000 omission, the Internal Revenue Ser vice must assert a notice of deficiency no later thana. March 15, 2009. b. April 15, 2009.c. March 15, 2012 d. April 15, 2012

9. Explain from whom the government may collect unpaid taxes.

Liability for Tax

• If spouses file a joint return, liability for taxes is joint and several

–Government can collect from either spouse regardless of who has income

–Tax may be collected from transferees and fiduciaries

Liability for TaxInnocent spouse relief -- if all met:

• Innocent spouse (IS) files a joint return

• Understatement due to other spouse’s erroneous item(s) of filing return

• IS did not know or had no reason to know of understatement

• Inequitable to hold IS liable• IS elects relief w/in two years

after IRS begins collection efforts

10. Understand government imposed practice standards for tax practitioners.

Professional Responsibilities

• Tax professionals have responsibilities to both tax system and to clients

• Sources of Guidance–Circular 230–AICPA Code of Professional

Conduct–Statements on Standards for Tax

Services

Tax Practice Issues(1 of 2)

• Tax preparer penalties

–IRS may impose various penalties on tax return preparers for misconduct

• Treasury Department Circular 230

–Regulates the practice of attorneys, CPAs, enrolled agents, and enrolled actuaries before the IRS

Tax Practice Issues(2 of 2)

• Tax accounting and law

–Accountants must be careful to avoid the unauthorized practice of law

• Accountant-client privilege

–Similar to attorney-client privilege, but it only applies in very limited circumstances

Professional Responsibilities• Avoidance versus evasion• Preparer penalties

–Penalties may not be covered by malpractice insurance

–Penalties are not deductible–Penalties may result in an IRS

review of the preparer’s entire practice

–Criminal tax evasion penalties include fines and prison

[Sec. 6695] If you are a tax preparer, which of these penalties may be assessed to you?

a. $50 per return for failure to furnish a copy of the return to the taxpayer

b. $50 per return for failure to furnish preparer’s identifying number to the taxpayer 

c. $50 per return for failure to maintain copies of returns prepared or maintain a listing of clients 

d. All of these

[Sec. 6694(a)] Willie is the owner of a CPA

accounting firm. Willie prepared an income tax return for a client and opined that a deduction can be claimed for a bad debt. If the return is examined and the deduction is disallowed, Willie will not be subject to a penalty for an unrealistic position if at a minimum:

a. The position on the return had a 10% probability of being sustained on the merits.

b. The position on the return had at least a one-in-three chance of being sustained on its merits. 

c. The position will “more likely than not” be sustained. 

d. All of these IRS-2001 

[Pg. 34] (Circular 230) Mike is an enrolled agent.

Widget, Inc. is an accrual basis taxpayer. In 2006, while preparing Widget’s 2005 return, Mike discovered that Widget failed to include income on its 2004 return that Widget received in 2005, but that should have been included in income in 2004 under the accrual method of accounting. What must Mike do?

a. Advise Widget of the error and the consequences of the error.

b. Include the income on the 2005 return.  c. Refuse to prepare Widget’s 2006 return until

Widget agrees to amend its 2000 return to include the amount in income.  

d. Change Widget to the cash method of accounting. IRS-2003 

Sources of Guidance.

Name three sources of guidance for tax professionals.

Answer.

Treasury Circular 230: Regulations Governing the Practice of Attorneys, Certified Public Accountants, Enrolled Agents, Actuaries and Appraisers before the Internal Revenue Service, and the AICPA’s Code of Professional Conduct and Statements on Standards for Tax Services all contain guidelines for tax professionals.

SSTS. Statement on Standards for Tax Services No. 4 states that a CPA may use estimates in completing a tax return.

When would using estimates be appropriate in tax return preparation?

Solution:

Estimates are appropriate when records are missing (for example, a flood or fire destroying records) or precise information is not available at the time of filing the tax return.

Evaluating Authority.

Georgia researched a major tax plan for a client.

She discovered a case in a circuit that is not the client’s circuit that is unfavorable to the client.

She has also found a revenue ruling that appears to have facts similar to her client’s that sanctions the preferred alternative.

Evaluating Authority.

Solution:

Can Georgia recommend the tax plan to her client without possible adverse consequences?

Does the plan meet the requirement of having a realistic possibility of being sustained on its merits?

The

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