2 - 1 ©2004 prentice hall, inc. the tax practice environment chapter 2

2 - 1©2004 Prentice Hall, Inc.

The Tax PracticeEnvironment

Chapter 2


Tax Practice

Tax compliance Preparing returns Representation of client at IRS audit

Tax planning Evaluating the tax consequences

associated with a transaction and making recommendations that will achieve the desired objective at a minimal tax cost


Taxes and Cash Flow

Tax cost is the increase in tax for the period and is a cash outflow

Tax savings is a decrease in tax for a period and is a cash inflow Expense payment generates an outflow but

deduction generates a tax reduction Reducing income taxes paid is a pure cash

inflow because tax savings are not taxable


Taxes and Cash Flows

Cash flows in future years are discounted to their present value so they can be compared using comparable dollars

The marginal tax rate is the rate that applies to the next dollar of income and is used when evaluating transactions that increase or decrease taxable income


Tax Planning Strategies

Timing income and deductions Defer recognition of income and accelerate

recognition of deductions Income shifting

Lower the total tax paid by splitting income among two or more taxpayers in the same family or between different entities owned by the same individual


Tax Planning Strategies

Changing the character of income Structure transaction to qualify for favorable

long-term capital gains rate Other factors affecting tax planning

Discount rate Inflation Uncertainty Nontax (personal) objectives Cost of implementation


Judicial Doctrines

Business purpose doctrine Transaction must have some business or economic

purpose other than a tax avoidance motive

Substance-over-form doctrine Taxability of a transaction is determined by the reality

of the transaction, rather than its appearance

Step transaction doctrine IRS can collapse a series of intermediate transactions

into a single transaction to determine the tax consequences


Sources of Authority

Primary authorities – statutory, administrative, and judicial

Secondary authorities – tax services, books, journals, and newsletters Secondary authorities used to locate and

interpret primary sources


Sources of Authority

Statutory sources – U.S. Constitution, tax treaties, and Internal Revenue Code

Legislative process – revenue bills begin in the House of Representatives

Committee reports indicate the legislative intent of a bill House Ways & Means Committee Senate Finance Committee Joint Conference Committee


Internal Revenue Code

A tax bill passed by Congress is usually enacted as a revenue act that amends the existing Internal Revenue Code

The Internal Revenue Code is divided into subtitles, chapters, subchapters, and sections

Citations to the Code usually are to sections (Sec. or §)


Administrative Sources

Treasury regulations provide explanations, definitions, examples, and rules that explain the language in the Code The root element of the regulation number (to the

right of the decimal) corresponds to the related section of the Code

Revenue rulings are published by IRS to clarify ambiguous tax situations

Letter rulings (PLR) can be requested by taxpayers who are uncertain about the correct tax treatment of a transaction


Judicial Sources

Case first heard by a trial court (U.S. Tax Court, District Court, U.S. Court of Federal Claims)

If either party is dissatisfied with the trial court decision, that party may ask an appellate court to review that decision

The controversy may be appealed to and decided by the U.S. Supreme Court

Each case has precedential value for future cases with the same fact pattern


JudicialJudicial

LegislativeLegislative

Primary Sources of Authority

AdministrativeAdministrative


Legislative Sources

Committee Reports

&

Floor StatementsThe

Internal Revenue Code


Administrative Sources

Internal RevenueService

Revenue Rulings

TreasuryRegulations

Revenue Procedures

Letter Rulings& other pronouncements


Judicial Sources

U. S. Court ofFederal Claims

U. S. Court ofAppeals for

Federal Circuit

U. S. District Court

U. S.Tax Court

U. S. Court ofAppeals

TheSupreme

Court


Tax Research

Purpose of research is to find solutions to tax problems

Steps in research process1. Gather the relevant facts and identify the

issues

2. Locate and evaluate the relevant authority

3. Communicate the recommendations


Tax Research

Identifying the issues is the most difficult step for many new researchers

Experienced professionals can state the relevant questions in terms of specific statutory authority and their questions frequently suggest the location of answers

Tax services (reference services) can be used to locate the authorities (refer to Appendix A for step-by-step instructions)


Tax Research

Reading the Code – read every Code section that is applicable and watch for language that indicates quantities or time period

Committee Reports – it is usually best to start with the Joint Conference Committee report as that will indicate whether the House or Senate version was enacted

Regulations – check the publication date to see if updated for the current Code


Tax Research

Revenue rulings – reflect current IRS policy and carry considerable weight

Letter rulings – apply on the taxpayers to whom they were issued

Acquiescence – IRS acquiesces when it agrees with a court decision it has lost and it issues a nonacquiescence when it disagrees with a decision


Tax Research

When a case involves a number of issues, the court will decide each issue separately

The party who raises an issue generally has the burden of proof (usually the taxpayer except for fraud)

The opinion is the court’s statement of the reasons for its decision

A reversal by an appellate court means that the party who won in the lower court now loses and the other party becomes the winner on that issue


Tax Research

Under the Golsen rule, the Tax Court must follow the decision of the Court of Appeals that has direct jurisdiction over the taxpayer

Citations for decisions should be checked in a citator to find out: The decision’s history What other courts have said about that case


Communicating the Recommendations

Memo to the file Facts Issues Conclusions Discussion of reasoning and authorities

Client letter


Filing a Tax Return

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)

Extension of time to file Individuals: 4 months + 2 extra months Corporations: 6 months


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) up to 25% maximum

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


Penalties

No failure-to-file penalty if no tax is owned Fraudulent failure to file can increase late

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

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


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 No time limit for fraud


Statute of Limitations

Refund claims must be initiated by taxpayer within later of: 3 years of filing date for return 2 years from date tax is paid


Selecting Returns for Audit

Information document matching program Mathematical/clerical error program Unallowable items program Discriminant function (DIF) formula Information provided by informant

Up to 10% reward Undercover operations


Audits and Appeals

Types of Audits Correspondence audit Office audit Field audit

30-day letter 30 days to request conference with Appeals

Division Appeals officer can consider hazards of

litigation


Appeals

90-day letter (statutory notice of deficiency) File petition with Tax Court within 90 days Pay the tax; can then go to court to sue for

refund Take no action and be subject to IRS enforced

collection procedures


Appeals

Trial Courts Tax Court is the only court that does not require

the taxpayer to first pay the tax and then sue for refund

Small Case Division of the Tax Court can hear disputes not exceeding $50,000 (but no appeal)

District Court and Court of Federal Claims cannot hear the case unless a suit for refund

Appellate Courts - Circuit Court of Appeals and Court of Federal Claims

Supreme Court – chooses the cases it will hear and accepts very few tax cases


Taxpayer Penalties

Noncompliance penalties 20% of tax underpayment for negligence 75% of tax underpayment for civil fraud Fines and prison for tax evasion (criminal

fraud) Burden of proof is on IRS to establish

beyond a reasonable doubt that the taxpayer committed fraud


Collection Procedures

IRS sends bill to taxpayer If no response, letter demanding payment in

10 days IRS can impose lien on taxpayer’s property

and seize assets Offer in compromise Innocent spouse relief


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


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


The End

2 - 1 ©2004 prentice hall, inc. the tax practice environment chapter 2

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tax practice tax compliance

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