chapter 12 tax administration & tax planning

Income Tax Fundamentals 2010 Gerald E. Whittenburg &

Martha Altus-Buller

2010 Cengage Learning

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


Ten service centers located around country° Responsible for processing information from tax

documents National computing center located in

Martinsburg, WV° Information from various service centers is

matched with records from other service centers


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° 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


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


Tax returns are selected for audit based upon a multitude of factors ◦ Correspondence audit – handled by mail and

usually involves questions about W-2s and 1099s◦ 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)

Note: Most common process for selecting returns for audit is based on DIF (Discriminant Function) score


When tax return is selected for examination, an agent is assigned

There are three 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

See Figures 2 and 3


Interest is charged to taxpayer for late taxes ◦ Interest paid is nondeductible consumer interest

Interest is paid to the taxpayer for refund ◦ Prior year 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, sample of recent rates:◦ First quarter 2009 5%◦ Second quarter 2009 4%◦ Third quarter 2009 4%◦ Fourth quarter 2009 4%


If a tax return is not filed by its due date (with extensions)◦ Penalty of 5% of tax is due per month or 15% if

fraudulently failing to file◦ Limited to 25% in total or 75% 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 tax return

This penalty is reduced by failure to pay penalty, if both penalties apply


Failure to Pay Penalty is 0.5% of tax for each month tax late◦ Maximum penalty is 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 for negligence or disregard of rules or regulations


Fraud penalty is assessed for filing a fraudulent tax return

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


Penalties, both civil and criminal, can be imposed for filing false withholding information

For filing a frivolous tax return For failing to file informational returns on a

timely basis (1099s, W-2s, etc) For not depositing payroll taxes on a timely

basis For underpaying estimated taxes For issuing a bad check for taxes


A taxpayer may not amend, nor may the IRS assess additional taxes, on a tax return for which the three year statute of limitations has expired - generally this is three years from due date

Exceptions◦ No statute of limitations if it is a fraudulent tax return◦ Six years 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 seven years


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


The IRS does not prescribe any minimum level of education for tax preparation

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


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


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


Document addresses taxpayers rights Requires the IRS to inform taxpayers of their

rights when dealing with the Service◦ It provides remedies for resolving disputes with IRS

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 – 12-20 for Taxpayer Bill of Rights


Tax planning refers to arranging one’s financial affairs so as to minimize tax liability

If illegal methods are use, this is called ‘tax evasion’


Tax planning can help taxpayers avoid tax traps

Tax trap is a provision that can result in the taxpayer’s loss of an otherwise available tax benefit◦ Watch for required deduction attributes like

reasonableness


Finished!


chapter 12 tax administration & tax planning

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