chapter 12
TRANSCRIPT
Chapter 12Chapter 12Tax Administration & Tax Tax Administration & Tax
PlanningPlanning
Income Tax Fundamentals 2011
Gerald E. Whittenburg & Martha Altus-Buller
2011 Cengage Learning
Learning ObjectivesLearning Objectives Identify organizational structure of the IRS Understand IRS audit process Define common penalties for taxpayers and
preparers Apply general rule for statute of limitations on
tax returns Describe rules that apply to tax practitioners
and the Taxpayer Bill of Rights Understand basic concepts of tax planning
2011 Cengage Learning
Internal Revenue Service (IRS)Internal Revenue Service (IRS)
Congress creates tax law and the IRS enforces it◦Includes assessment and collection
departments◦Is a branch of the Treasury Department◦Is headquartered in Washington DC
Commissioner of IRS is appointed by president and approved by Congress
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IRS Service CentersIRS Service Centers
Ten service centers located around country° Responsible for processing information
from tax documentsNational computing center located in
Martinsburg, WV° Information from various service centers
is matched with records from other service centers
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IRS Restructuring Act of IRS Restructuring Act of 19981998
This act sought to structurally and operationally change the IRS by creating operating units along functional lines° Service and Enforcement arm collects taxes and
audits tax returns, including two factions:• Small Business/Self-Employed (SB/SE) unit serves
SB/SE customers• Wages & Investment (W&I) division helps taxpayers
(that primarily pay taxes through withholdings) comply with applicable laws
See Figure 12.1 on page 12-3 for complete IRS organizational chart
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Examination of RecordsExamination of Records
IRS has authority to examine taxpayers’ accounting records and books in a process called an audit
IRS can summon taxpayers and require them to appear before the IRS and produce necessary accounting records◦ IRS may also summon taxpayer records from third
parties (CPAs, brokers, etc.)
Taxpayer should enlist professional tax advice if IRS summoning records from third parties!!
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Selection of Returns for AuditsSelection of Returns for Audits Tax returns are selected for audit based upon a
multitude of factors ◦ Correspondence audit – handled by mail and usually
involves questions about W-2s/1099s, certain itemized deductions or the earned income credit
◦ Office audit – conducted when individual taxpayer (usually without business involvement) is required to take records to district office to substantiate income, deductions and/or credits
◦ Field audit – conducted when records too extensive to take to IRS office (usually involves taxpayer engaged in business), generally for taxpayers with substantial business activities
Note: Most common process for selecting returns for audit is based on statistical sampling, called DIF (Discriminant Function) score
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Appeals ProcessAppeals Process
When tax return is selected for examination, an agent is assigned
There are 3 possible results from an audit◦ Agent determines that there are no changes◦ Agent and taxpayer agree that there is a change in
tax liability◦ Agent and taxpayer disagree on outcome
In this scenario, taxpayer may appeal through established appeals procedures
The IRS claims that through its recalibration process, fewer no-change audits are now conducted and larger assessments are levied
See Figures 12.2 and 12.3 on pages 12-8 and 12-9
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InterestInterest
IRS charges interest to the taxpayer for late taxes ◦ Interest paid is nondeductible consumer interest
IRS pays interest to the taxpayer for refunds◦ If the prior year’s audit reveals refund due◦ Interest received from IRS is income
Interest rate is adjusted quarterly based on the short-term federal rate plus 3 percentage points and is compounded daily for underpayment of taxes
Sample of recent rates:◦ First quarter 2010 4%◦ Second quarter 2010 4%◦ Third quarter 2010 4%◦ Fourth quarter 2010 4%
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Failure to File PenaltiesFailure to File Penalties If a tax return is not filed by its due date (with
extensions), IRS will impose penalties◦ Penalty of 5% of tax is due per month or 15% if
fraudulently failing to file
◦ Limited to 25% in total (or 75% in total if fraudulent)
◦ No penalty if no tax due or refund forthcoming
If tax return is not filed within 60 days of due date (with extensions), minimum penalty is:◦ Lesser of $135 or total amount of taxes due with return
The failure-to-file penalty is reduced by failure-to-pay penalty, if both penalties apply
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Other PenaltiesOther PenaltiesFailure-to-Pay Penalty is 0.5% of tax for each
month tax late◦ Up to maximum penalty of 25% of tax◦ Increases to 1% per month 10 days after notice of levy
filed◦ No penalty if there is no tax due or refund forthcoming
from IRS
Accuracy-Related Penalty◦ If calculations on tax return substantially understate
income tax, or substantially overstate value of an asset, penalty can be imposed
◦ Or can be levied for negligence or disregard of rules or regulations
If taxpayer can demonstrate reasonable cause for understatement of tax and that he/she acted in good faith, penalty will not be assessed
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Fraud PenaltyFraud Penalty
Fraud penalty is assessed for filing a fraudulent tax return
Calculated as 75% of the amount of taxes due if the IRS can prove with a “preponderance of evidence” that a taxpayer purposefully evaded tax by committing fraud◦ When the fraud penalty is assessed, the accuracy-
related penalty cannot be imposed
If taxpayer can demonstrate reasonable cause for understatement of tax and that he/she acted in good faith, penalty will not be assessed
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Other PenaltiesOther Penalties
Both civil and criminal penalties can be imposed for filing false withholding information
Also, assorted penalties foro Filing a frivolous tax return o Failing to file informational returns on a timely basis
(1099s, W-2s, etc)o Not depositing payroll taxes on a timely basiso Underpaying estimated taxeso Issuing a bad check for taxes
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Statute of LimitationsStatute of Limitations
A taxpayer may not amend, nor may the IRS assess additional taxes, on a tax return for which the 3-year statute of limitations has expired
Exceptions to 3-year statute ◦ No statute of limitations if it is a fraudulent tax
return◦ 6-year statute of limitations if amount of gross
income omitted exceeds 25% of total gross income◦ Statute of limitations for deduction of a bad debt or
worthless security is 7 years
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Statute of LimitationsStatute of Limitations
If IRS and taxpayer agree, Form 872 may be signed that allows for extension of statute of limitations
If tax deficiency has been assessed by the IRS within the period of the statute, then government has ten years from the date of assessment to collect the tax due
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Tax PractitionersTax Practitioners The IRS will begin regulating paid preparers by
requiring registration, competency exams and continuing educationo CPAs, enrolled agents, attorneys and all paid
preparers will be required to register and pay fee if engaged in paid preparation after 12/31/10
Only CPAs, attorneys or enrolled agents may represent clients at IRS proceedings
There are a multitude of preparer penalties ◦ For example, if tax preparer does not exercise due
diligence, tax returns are not signed, or copy is not provided to clients, the tax preparer may be assessed a penalty
See pages12-15 and 12-16 for full list of preparer penalties
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Burden of ProofBurden of Proof
In most civil tax cases the IRS has historically placed burden of proof on taxpayer
IRS Restructuring & Reform Act of 1998 changed tax law to shift burden of proof to IRS in many cases◦ Burden of proof automatically shifts to IRS in two
situations IRS uses statistics to reconstruct an individual’s income Court proceeding against an individual taxpayer involves
penalty/addition to tax
◦ In certain situations, burden of proof still rests with the taxpayer (such as corporations, partnerships or estates with a net worth in excess of $7 million).
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Tax Confidentiality Tax Confidentiality PrivilegePrivilege
The attorney-client privilege has been extended in limited circumstances to non-attorneys who are authorized to practice in front of the IRS ◦ CPAs and enrolled agents
◦ This may be asserted only in a noncriminal tax proceeding before the IRS or federal courts
◦ This privilege does not extend to written communications between tax practitioner and a corporation in connection with promotion of tax shelter
Does not automatically extend to state tax situations
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Taxpayer Bill of RightsTaxpayer Bill of Rights
Document addresses taxpayers rights Requires the IRS to inform taxpayers of their
rights and remedies when dealing with the Service◦ It provides remedies for resolving disputes with IRS
◦ Has been amended several times since issuance
Part I – Declaration of Taxpayer Rights◦ Directs taxpayer to other IRS publications for more
details
Part II –Examinations, Appeals, Collections & Refunds
Note: See pages 12-19 and 12-20 for Taxpayer Bill of Rights
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Tax PlanningTax Planning Tax planning refers to arranging one’s financial affairs
so as to minimize tax liability There are two types of financial transactions
o In an “open” transaction, tax planning may still occur as transaction has not been culminated
o In a “closed” transaction, tax consequences are already finalized and presentation to the IRS is limited to identifying facts in the most favorable light possible
Tax planning based on marginal tax rateo This is the rate applied to the “next dollar of income” or the
“next dollar of deduction” and should be used when engaging in tax planning (not the average tax rate)
If illegal methods are used, this is called ‘tax evasion’
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Tax Traps Tax Traps A “tax trap” is a provision in tax law
that can result in the taxpayer’s loss of an otherwise available tax benefit◦Watch for required deduction attributes
like reasonableness or “ordinary and necessary”
◦Be aware of limitations such as at-risk loss limitations
Tax planning can help taxpayers avoid tax traps
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Finished!
2011 Cengage Learning