2 - 1 ©2005 prentice hall, inc. the tax practice environment chapter 2

2 - 1©2005 Prentice Hall, Inc.

The Tax PracticeEnvironment

Chapter 2


Tax Practice

Tax compliance Preparing returns Representing clients 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

When marginal tax rates are expected to change from year to year, timing of transactions should be controlled to minimize tax costs and maximize tax savings


Tax Planning Strategies

Timing income and deductions General rule - defer recognition of income

and accelerate recognition of deductions Recognize income in year with lowest

marginal tax rate Deduct expenses in year with highest

marginal tax rate



Shifting income 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

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 A transaction must have a business or economic

purpose other than tax avoidance

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


JudicialJudicial

StatutoryStatutory

Primary Sources of Authority

AdministrativeAdministrative


Statutory Sources of Authority

U.S. Constitution Internal Revenue Code Tax treaties Committee reports that indicate the legislative

intent of a bill House Ways & Means Committee Senate Finance Committee Joint Conference Committee


Tax Legislative Process

Tax bill introduced in the house Referred to the House Ways and Means

Committee Submitted to the full House to be debated

under closed rule If passed, bill is sent to the Senate Referred to the Senate Finance Committee


Tax Legislative Process

Submitted to the Senate to be debated under open rule

If House and Senate versions differ, referred to a Joint Conference Committee where a compromise version of the bill

If compromise bill passed by both houses of Congress, the bill is submitted to the President for his signature


Internal Revenue Code

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

Code divided into subtitles, chapters, subchapters, and sections

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


Administrative Sourcesof Authority

Internal RevenueService

Revenue Rulings

TreasuryRegulations

Revenue Procedures

Letter Rulings& other pronouncements


Judicial Sources

U. S. Court ofFederal Claims

U. S. Court ofAppeals for

Federal CircuitU. S. District Court U. S. Court of

Appeals

TheSupreme

CourtU. S. Tax 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


Identify the Issues

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


Locate & Evaluate Authorities

Tax services (reference services) can be used to locate the authorities

Internal Revenue Code – read every Code section that is applicable and watch for language that indicates quantities or a 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 latest amendments to the Code


Locate & Evaluate Authorities

Revenue rulings – reflect current IRS policy and carry considerable weight

Letter rulings – binding only for taxpayers to whom they were issued

Court Cases Tax Court Federal District Courts U. S. Court of Federal Claims Appellate Courts


Evaluating Judicial Authorities

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



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



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


Completing Your Research

When to stop searching What is level of authority located? Is position supported in IRS rulings? Do different authorities cite the same

authority?


Communicating Recommendations

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

Client letter


Filing Deadlines for Tax Returns

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: 4 months + 2 extra months Corporations: 6 months


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 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 fraudulent returns


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


Audits and 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


Going to Court

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 ©2005 prentice hall, inc. the tax practice environment chapter 2

Documents

tax consequences

tax practice tax compliance

total tax

tax reduction

tax costs

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minimal tax cost slide

marginal tax rates