Ch.2 Tax Compliance, the IRS, and Tax Authorities
Types of Audits
-correspondence examinations -office examinations -field examinations
Treasury Department's official interpretation of the Internal Revenue Code
3 Different Forms: Final Temporary Proposed 3 Different Purposes: Interpretative Procedural Legislative
Extensions
An extension allows the taxpayer to delay filing a tax return, but it does NOT extend the due date for tax payments. -The taxpayer should estimate how much tax will be owed and pay by the original due date.
Tax Sources
Are the following primary or secondary sources? Internal Revenue Code (Primary) Tax Article in USA Today (Secondary) Article on Supreme Court Opinion (Secondary) Supreme Court Opinion (Primary) RIA Federal Tax Coordinator (Secondary) Treasury Regulations (Primary)
Benita is concerned that she will not be able to complete her tax return by April 15. Can she request an extension to file her return? By what date must she do so? Assuming she requests an extension, what is the latest date that she could file her return this year without penalty?
Benita can file an automatic six month extension to file her tax return. This extension must be filed by April 15th. October 15th is the latest date she can file her return without penalty. If October 15th falls on a Saturday, Sunday, or holiday, the extended due date will be the 1st day after October 15th that is not a Saturday, Sunday, or holiday.
Statute of Limitations Example
Bill and Mercedes file their 2014 federal tax return on September 6, 2015, after receiving an automatic extension to file their return by October 15, 2015. When does the statute of limitations end for their 2014 tax return? September 6, 2018 (3 years after the later of the actual filing date and the original due date)
Mason was shocked to learn that the current Code is the Internal Revenue Code of 1986. He thought that U.S. tax laws change more frequently. What is wrong with Mason's perception?
Congress enacts tax legislation virtually every year that changes the Code. 1986 is simply the last major overhaul of the Internal Revenue Code. All enacted changes are incorporated into the Internal Revenue Code of 1986.
Return Due Date Examples
Corporation XYZ, Inc. has a tax year which ends on August 31st. When will their tax return be due? -December 15th Assume they filed an extension, when would the tax return be due? -June 15th
Approximately what percentage of tax returns does the IRS audit? What are the implications of this number for the IRS's strategy in selecting returns for audit?
Currently, less than 1 percent of all tax returns are audited. The IRS must be strategic in selecting returns for audit in an effort to promote the highest level of voluntary taxpayer compliance.
tax return due date; individuals, c-corps
Individuals: 15th day of 4th month following end of tax year. (April 15) Due dates on a Saturday, Sunday, or holiday are extended to next business day Individuals: 6 month extensions (Oct 15)
Jamarcus, a full-time student, earned $2,500 this year from a summer job. He had no other income this year and will have zero federal income tax liability this year. His employer withheld $300 of federal income tax from his summer pay. Is Jamarcus required to file a tax return? Should Jamarcus file a tax return?
Jamarcus is not required to file an income tax return because his gross income of $2,500 is well below the gross income threshold for a single taxpayer. However, he should file a tax return to receive a refund of the $300 previously withheld.
Field Examinations (type of audit)
Least common audit -Held at the taxpayer's place of business and can last months to years
Correspondence examinations
Most common audit -Conducted by mail and are generally limited to 1 or 2 items on the return
Primary Authorities:
Official sources of tax law -Statutory sources (e.g., Internal Revenue Code) -Judicial sources (the courts) -Administrative sources (IRS pronouncements) Statutory Authorities: 1)Internal Revenue Code 2)Committee Reports: Senate Finance Committee Report 3)House Ways and Means Committee Report Administrative Authorities: 1)Final Regulation 2)Temporary Regulation 3)Proposed Regulation 4)Revenue Ruling 5)Revenue Procedure 6)Private Letter Ruling 7)Technical Advice Memorandum Judicial Authorities: 1)U.S. Supreme Court 2)U.S. Circuit Court of Appeals 4)U.S. Tax Court—Regular decision 5)U.S. Tax Court—Memorandum decision 6)U.S. Court of Federal Claims 7)U.S. District Court
Tax Law Sources
Primary authorities Secondary authorities
Secondary Authorities:
Unofficial tax authorities -Tax services -Tax articles Tax Research Services: 1)BNA Tax Management Portfolios 2)CCH Standard Federal Tax Reporter 3)CCH Tax Research Consultant 4)RIA Federal Tax Coordinator 5)RIA United States Tax Reporter Newsletters: 1)Daily Tax Report 2)Federal Tax Weekly Alert 3)Tax Notes Law Reviews: 1)Tax Law Review (New York University School of Law) 2)Virginia Tax Review (University of Virginia School of Law) Professional Journals: 1)Journal of Accountancy 2)Journal of Taxation 3)Practical Tax Strategies 4)Taxes 5)Tax Adviser Quick Reference Sources: 1)IRS Publications 2)CCH Master Tax Guide 3)RIA Federal Tax Handbook Textbooks: 1)McGraw-Hill's Taxation of Individuals and 2)Business Entities McGraw-Hill's Essentials of Federal Taxation
Paula could not reach an agreement with the IRS at her appeals conference and has just received a 90-day letter. If she wants to litigate the issue but does not have sufficient cash to pay the proposed deficiency, what is her best court choice?
The U.S. Tax Court, the only court that allows tax cases to be heard before the taxpayer pays the disputed liability.
Sophia recently won a tax case litigated in the 7th Circuit. She recently heard that the Supreme Court denied the writ of certiorari. Should she be happy or not, and why?
The denial of the writ of certiorari means that the Supreme Court has decided not to hear Sophia's case. Thus, Sophia should be happy as 7th Circuit's ruling will not be reversed by the Supreme Court.
Agua Linda, Inc., is a calendar-year corporation. What is the original due date for the corporate tax return? What happens if the original due date falls on a Saturday?
The original due date for Agua Linda, Inc.'s corporate tax return is April 15th. If the 15th falls on a Saturday, Sunday, or holiday, the due date will be the 1st day after April 15th that is not a Saturday, Sunday, or holiday. In this example, Agua Linda, Inc.'s due date is April 17th (i.e., the Monday after Saturday the 15th).
Latoya filed her tax return on February 10th this year. When will the statute of limitations expire for this tax return?
The statute of limitations generally ends three years from the later of (i) the date the tax return was actually filed (3 years from February 10th of this year) or (ii) the tax return's original due date (3 years from April 15th of this year). Accordingly, Latoya's statute of limitations for the tax return will end 3 years from April 15th.
Laura Li, a U.S. resident, works for three months this summer in Hong Kong. What type of tax authority may be especially useful in determining the tax consequences of her foreign income?
The tax treaty between the U.S. and Hong Kong.
Describe the differences between the three types of audits in terms of their scope and taxpayer type.
The three types of IRS audits consist of correspondence, office, and field examinations. Correspondence examinations are the most common. These audits (as the name suggests) are conducted by mail and generally are limited to one or two items on the taxpayer's return. Among the three types of audits, correspondence audits are generally the most narrow in scope and least complex. Office examinations are the second most common audit. As the name suggests, the IRS conducts these audits at the local IRS office. These audits are typically broader in scope and more complex than correspondence examinations. Small businesses, taxpayers operating sole proprietorships, and middle to high-income individual taxpayers are likely candidates for office examinations. In these examinations, the taxpayer receives a notice that identifies the items subject to audit, requests substantiation for these items as necessary, and notifies the taxpayer of the date, time, and location of the exam. Taxpayers may attend the examination alone, or simply let their tax adviser or attorney attend on the taxpayer's behalf. Field examinations are the least common audit. The IRS conducts these audits at the taxpayer's office (i.e., place of business), or the location where the taxpayer's books, records and source documents are maintained. Field examinations are generally the broadest in scope and most complex of the three audit types. They can last many months to multiple years and generally are limited to business returns and the most complex individual returns.
Compare and contrast the three types of tax law sources and give examples of each.
The three types of tax law sources include statutory authority issued by Congress (e.g., the Internal Revenue Code, committee reports), judicial authority (i.e., rulings by the U.S. District Court, U.S. Tax Court, U.S. Court of Federal Claims, U.S. Circuit Court of Appeals, or U.S. Supreme Court), administrative authority (e.g., regulations, revenue rulings, and revenue procedures). In addition to being issued by different groups, the format and purposes of each of these authorities are different. Whereas statutory authorities are tax laws enacted by Congress, judicial and administrative authorities generally interpret enacted tax laws.
IRS Audit Selection
IRS uses computer programs to identify tax returns which might have an understated liability. -Discriminant Function (DIF) system (scoring system) -Document perfection (checks for math errors, etc.) -Information matching programs (compares tax return data with other IRS information)
Explain the difference between the DIF system and the National Research Program. How do they relate to each other?
(1) The DIF system is basically a scoring system that assigns a score to each tax return that represents the probability that the tax liability on the return has been underreported (i.e., a higher score, a higher likelihood of underreporting). The IRS derives the weights assigned to specific tax return attributes from historical IRS audit adjustment data from the National Research Program (NRP). The NRP analyzes randomly selected returns to ensure that the DIF scorings are representative of the population of tax returns. The DIF system then uses these (undisclosed) weights to score each tax return based on the tax return's characteristics. Returns with higher DIF scores are then reviewed to determine if an audit is the best course of action.
Name three factors that determine whether a taxpayer is required to file a tax return.
(1)Filing status (e.g., single, married filing joint, etc.), (2)age (3) taxpayer's gross income.
tax return due date; S corporations,Partnerships
-15th day of the 3rd month following end of tax year. (March 15) -Due dates on a Saturday, Sunday, or holiday are extended to next business day - 6 month extensions (Sep 15)
Ahmed does not have enough cash on hand to pay his taxes. He was excited to hear that he can request an extension to file his tax return. Does this solve his problem? What are the ramifications if he doesn't pay his tax liability by April 15?
Extensions allow the taxpayer to delay filing a tax return but do not extend the due date for tax payments. If a taxpayer fails to pay the entire balance of tax owed by the original due date of the tax return, the IRS charges the taxpayer interest on the underpayment from the due date of the return until the taxpayer pays the tax. The interest rate charged depends on taxpayer type (e.g., individual vs. corporation) and varies quarterly with the federal short-term interest rate. The interest rate for tax underpayments for individuals equals the federal short-term rate plus three percentage points.
What are the basic differences between regulations, revenue rulings, and private letter rulings?
Regulations are the Treasury Department's official interpretation of the Internal Revenue Code and have the highest authoritative weight among regulations, revenue rulings, and private letter rulings. Regulations are issued in three different forms: proposed, temporary, and final. In addition to being issued in three different forms, regulations also serve three basic purposes: interpretative, procedural, and legislative. Unlike regulations, revenue rulings address the specific application of the Code and regulations to a specific factual situation. Thus, while revenue rulings have less authoritative weight, they provide a much more detailed interpretation of the Code as it applies to a specific transaction and fact pattern. Letter rulings are less authoritative but more specific than revenue rulings and regulations. Letter rulings generally may not be used as precedent by taxpayers. However, they may be cited as authority to avoid the substantial understatement of tax penalty under IRC Sec. 6662 imposed on taxpayers and related tax practitioner penalty under IRC Sec. 6694. Private letter rulings represent the IRS's application of the Code and other tax authorities to a specific transaction and taxpayer. Private letter rulings are issued in response to a taxpayer request and are common for proposed transactions with potentially large tax implications.
office examinations
Second most common audit -Conducted in the local IRS office and tends to be broader in scope
Statute of limitations:
the time in which the taxpayer can file an amended return or the IRS can assess a tax deficiency -Generally ends 3 years from the later of (1) the date the tax return was actually filed (2) the tax return's original due date