Ethics: Federal tax practice and procedures

Administrative Authority

Legislative regulations have almost as much weight as the IRC itself. Other types of regulations have very significant authority within the context of administrative authority. Revenue Rulings are the next highest source of authority. Private Letter Rulings apply only to the taxpayer who requested the ruling.

Reasonable cause

No penalty is imposed if (a) there was "reasonable cause" for the underpayment and (b) the taxpayer acted with "good faith." *Reasonable cause* - The exercise of ordinary care, *Judged objectively* example: Reliance on tax adviser and/or Reliance on advice of IRS employee.

Late Payment of Tax

Penalty is 0.5% of the net tax due per month (up to 25%). example: Mary files her tax form in a timely manner but does not pay her tax until two months after it is due. She owes $10,000 in tax. She must now pay the $10,000 in tax plus a $100 penalty [2 (months) × (.5%) × $10,000 = $100]. Taxpayers who have requested an extension by the due date and paid at least 90% of taxes owed will not face a failure-to-pay penalty. A "reasonable cause" defense applies (example: serious illness strikes on the eve of the filing deadline).

Taxpayer penalties - Late Filing or Failure to File

Penalty is 5% of the net tax due per month (up to 25% of unpaid taxes). If the failure to file is fraudulent, the penalty becomes 15% per month (up to 75% of unpaid taxes). For returns filed more than 60 days after the due date (taking into account extensions granted), the minimum penalty is (in 2018) the lesser of $205 or 100% of the unpaid tax.

Appeals process

To appeal, a written protest must be filed with the request for an appellate conference - protest must explain the taxpayer's position for each issue and provide the support on which the taxpayer is relying for questions of law The IRS is not required to grant an appeal in all cases. If the case is settled, a Form 870-AD is signed, which means that the case will not be reopened unless there is a significant mathematical error or fraud.

Standards of belief

Undisclosed position—"Substantial authority" (≥40% chance of being sustained) Disclosed position—"Reasonable basis" (≥20% chance of being sustained) Tax shelter position—"More likely than not" (>50% chance)

Tax Fraud

Willfully making and subscribing to any document made under penalty of perjury that the taxpayer does not believe to be true as to every material matter Willfully aiding the preparation of any tax-related matter that is fraudulent as to any material matter Removing or concealing property with intent to defeat taxes

Tax shelters

if a significant purpose of the partnership, entity, plan, or arrangement is the "avoidance or evasion" of income tax. Substantial understatements are not offset by disclosed tax treatments with reasonable basis, or substantial authority for tax shelters.

Substantial understatement for *individuals*

is one that exceeds the greater of: 10% of the tax, or $5,000. example: Tax $10,000 but reported $6,000, understatement = 4,000 5,000 > 10%; 4,000 < 5,000; not a substantial understatement

Substantial understatement for *Non S-Corps*

is one that exceeds the lesser of: 10% of the tax (or, if greater, $10,000), or $10 million.

Internal Revenue code

is the codification of the tax laws promulgated by Congress. Steps for passing a tax law: 1. Tax bills originate in House Ways and Means Committee 2. Passed by House of Reps 3. Moves to Senate Finance Committee 4. Senate debates bill and passes its own version 5. Since house and senate bills differ, a Joint Conference Committee is created to craft a compromise bill 6. The compromise bill returns to house and senate for another vote 7. The president either signs or vetoes bill 8. Congrass can override a veto with a two-thirds vote

Two types of authority: Primary and Secondary

(1) Primary authority consists of the original sources of the law, Primary authority comes from each of the three branches of the federal government. Legislative authority Administrative authority Judicial authority (2) Secondary authority is commentary on tax law such as treatises, journals, and commentaries provided by editorial services.

90 day letter

the IRS letter received after an audit and receipt of the 30-day letter that explains that the taxpayer has 90 days to either (1) pay the proposed deficiency or (2) file a petition in the U.S. Tax Court to hear the case. The 90-day letter is also known as the statutory notice of deficiency. If the petition is not filed in a timely manner, the taxpayer's only judicial recourse is through a U.S. District Court or a U.S. Claims Court, both of which require the deficiency to be paid before the judicial process can begin.

Underpayments due to disregard

"Disregard" may be negligent, reckless, or intentional. Negligent and reckless disregard largely overlap with the "negligence" provision of the statute. Intentional disregard may be problematic but is not necessarily wrongful just because the taxpayer takes a tax position that is ultimately found to be erroneous. A "good-faith" mistake of law provides a defense. 1. Disclosure of a position on a Form 8275 or 8275-R may provide a defense to any penalty for intentional disregard if the position has a reasonable basis and the taxpayer has kept adequate books and records to properly substantiate necessary items.

Underpayments due to negligence

"Negligence" is "any failure to make a reasonable attempt to comply with" the rules. 1. Failure to keep adequate books and records. 2. Taxpayer conduct—Did the taxpayer make reasonable attempts to get it right? 3. Taxpayer positions—A taxpayer position that lacks a "reasonable basis" may be attributed to negligence. 4. Disclosure of a position that is negligently taken is not a defense.

Tax Preparer Penalties

"unreasonable position" = greater of 1,000 or 50% of the income derived by the preparer for preparing the return unreasonable position and the preparer willfully attempts to understate the tax liability or recklessly or intentionally disregards rules or regulations = greater of $5,000 or 75% of the income earned by the tax preparer no penalty. If a preparer takes a position on a return that understates the true tax liability, the preparer will not be subject to a penalty if the position taken has substantial authority.

Underpayments and penalties

20% penalty on the following underpayments: 1. Underpayments attributable to negligence or disregard of rules or regulations 2. Substantial understatement of income tax. This amount is offset by amounts for which the tax treatment is adequately disclosed and there is a reasonable basis (≥20% chance of being sustained) for the tax treatment. Or there was substantial authority for claimed tax treatment. 3. Undisclosed position must be supported by substantial authority which requires a ≥40% chance of being sustained.

Tax evasion

26 U.S.C. Section 7201 punishes tax evasion and is applied very broadly. This provision has been used to prosecute, among other wrongs: Failure to file a return Falsifying income Falsifying amounts that reduce taxable income To secure a conviction, the government must prove: An affirmative act constituting an attempt to evade or defeat payment of a tax; Willfulness; and Existence of a tax deficiency. Maximum punishment for individuals: fine of $100,000 and/or 5 years in jail.

Communicating Research

A research memorandum should include the following key procedures: Document all relevant facts. Clearly describe the issue investigated. Report conclusions. Summarize rationale and authorities that support conclusions. Summarize key authorities used in research.

privileged communication

Any communication that would be privileged between a taxpayer and an attorney is also privileged between a taxpayer and any person who is authorized to practice before the IRS. This privilege does not apply to criminal tax matters or to corporate tax shelters.

Signing a return

A taxpayer must sign a tax return for it to be complete. Both spouses must sign a joint return. This creates joint and several liability for each spouse, which means that the IRS can collect the entire tax liability from either spouse. No sign= no refund eFile = electronic signature with a PIN, both spouses need to enter PIN for joint, no papers need to be mailed if filed electronically. A parent or guardian can sign a child's return as a the child's rep. A tax return is signed under the penalty of perjury. If a taxpayer knowingly signs a false tax return, the taxpayer can be subject to civil and/or criminal penalties. See the "Compliance Responsibilities" lesson for more detail.

CPA who is engaged in providing tax services is subject to

AICPA's Code of Professional Conduct. AICPA's Statements on Standards for Tax Services. Circular 230

Offer in Compromise (OIC)

An offer in compromise may be agreed to by the IRS, which allows a taxpayer to settle a tax liability for less than the actual amount owed.

Legislative authority

Authority from Congress. Sources include: The Constitution, 16th Amend. authorizes the income tax. The Internal Revenue Code Statutes. Treaties Committee Reports of the House Ways and Means Committee, Senate Finance Committee, and the Joint Conference Committee

Administrative authority

Authority from the Treasury Department and Internal Revenue Service. Most significant pronouncements are as follows: 1. Treasury Regulations— Regulations are published in the Federal Register and later in the Internal Revenue Bulletin. Regs can be classified as: Legislative - interpretative, procedural. 2. Revenue Rulings - Do not have as much weight as regulations Are limited to a given set of facts Deal with more specific issues than regulations 3. Private Letter Rulings - Request by the taxpayer for the IRS to provide the tax consequences on a specific set of facts 4. Revenue Procedures —These provide internal management practices of the IRS. 5. Technical Advice Memoranda - These are requested by the IRS field agents during an audit. They apply only to the affected taxpayer. Other sources of authority include notices, announcements, and general council memoranda.

Legislative Authority

Congress has the last word on what the federal tax law should be. Hierarchy of sources of tax authority. 1. US Constitution 2. IRC 3. If a treaty exists with a foreign country, the provisions of the treaty control the tax consequences of a transaction

Judicial authority

Courts of Original Jurisdiction—Any tax dispute not resolved between the taxpayer and the IRS that goes to court must begin in a court of original jurisdiction. 1. US Tax Court - hears only tax cases, one court, 19 judges travel throughout the country to hear cases. No Jury trial. Taxpayer doesn't have to pay deficiency before trial, as long as petition is filed in a timely manner. Acquiescence policy - The IRS has adopted an acquiescence policy for regular Tax Court decisions that it loses. Acquiescence indicates that the IRS will follow the decision in future situations, involving similar facts and issues. Nonacquiescence indicates that the IRS will not follow the decision and can be expected to litigate in situations involving similar facts and issues. Decision of the tax courts are appealed to the us court of appeals. 2. U.S. District Courts Jury trial is possible. Must pay deficiency first and then sue the IRS for a refund Judges are not tax specialists since all types of legal matters are tried. Many different district courts throughout the country 3. Court of federal claims: There is only one court in Washington, D.C. Must pay deficiency first and then sue the IRS for a refund 16 judges, who are not tax specialists, since all types of legal matters are tried Jury trial is not available. 4. U.S. Tax Court—Small Cases Division a. $50,000 or less, no appeal. 5. U.S. Court of Appeals Hears appeals from Tax Court and District Court 11 circuits plus the District of Columbia Circuit District court must follow the decision/precedent of the Circuit Court of Appeals for the circuit in which the District Court is located Tax Court will follow previous decisions in the Circuit that will have jurisdiction on appeal (Golsen rule).

Good Faith

Definition—Honesty of purpose *Judged subjectively* Examples: Reliance on erroneous W-2, with no red flags to indicate its inaccuracy. Reliance on erroneous advice of tax adviser where: Adviser was given all facts and circumstances; Advice was not based on unreasonable assumptions; and If the advice was that a regulation was invalid, the position was adequately disclosed.

Disclosure

Disclosure can help avoid liability by demonstrating that the taxpayer was acting in good faith and not trying to pull a fast one or otherwise sneak a position past the IRS. Penalties can be avoided if: 1. Disclosed (on form 8275-R, Regulation Disclosure Statement - for positions contrary to treasury regulations) 2. meets good-faith challenge 3. reasonable basis 4. kept adequate books and records or otherwise substantiated items properly.

Discriminate function system - DIF

Each return is given a score from formulas that are part of the Discriminate Function System (DIF). The DIF score is used to determine which returns to review for possible audit.

IRS Audit findings

IRS reports its findings in an Income Tax Examination Changes Report.

Researching a tax issue:

Identify all relevant facts. Clearly state problem to be solved. Locate applicable tax authority. Evaluate the relevance of the authorities. Determine alternative solutions. Determine most appropriate solution. Communicate results.

Revenue Agent's Report (RAR)

If the taxpayer agrees to the audit changes proposed in the Revenue Agent's Report (RAR), he or she cannot pursue tax relief through the appeals process or through the Tax Court. note that a signed agreement binds the IRS and taxpayer with regard to only items in the agreement.

Fraudulent underpayments

Obviously there is no reasonable cause or good-faith defense when a taxpayer attempts to commit fraud. When the underpayment is allegedly fraudulent, the 75% penalty applies to the return's entire understatement, unless the taxpayer can establish that parts of it were not attributable to fraud.

Substantiation

Substantiation can help avoid liability by establishing entitlement to a claimed position and also indicating good faith by a taxpayer who is trying to get things right. Penalties maybe imposed if: 1. Failure to keep adequate books and records: a. Deductions that are often questioned include: Home office deductions Vehicle mileage Gifts to clients Food and entertainment b. Records that should be retained: All tax returns for the previous seven years All records that pertain to a return for the previous three years Other records, no matter how old, that would be needed to support a tax position on a subsequent return 2. Failure to substantiate items that gave rise to the underpayment. Among others, taxpayers are required to substantiate: Charitable contributions—The taxpayer must have a receipt for large donations to a charitable organization. Donations ≥ $250 must be documented with a receipt. Donations > $5,000 generally require a qualified appraisal. Business use of an automobile—The taxpayer must track the miles driven for business use in a timely kept log. 3. Good faith provides a defense to even a failed effort.

Regulation numbering

The numbers preceding the decimal point indicate the type of regulation or applicable area of tax law to which they pertain, while the numbers immediately following a decimal point indicate the Internal Revenue Code section being interpreted.

Tax preparer must also sign

The tax preparer must also sign the tax return and provide a PIN. Failure to do so results in a $50 penalty to the tax preparer for each failure (maximum of $25,000 in any calendar year).

Judicial authority

The weighting of a judicial decision depends on: 1. Level of court 2. Legal residence of the taxpayer 3. Whether the IRS has acquiesced to the decision (meaning that the IRS has indicated that it will follow the decision in the future) 4. The date of the decision 5. Whether later decisions have concurred with opinion

If no agreement is reached between IRS and taxpayer

through the audit process, the taxpayer will receive a copy of the RAR and a 30-day letter. The IRS encourages the taxpayer to agree to the RAR or request an appellate conference. However, the taxpayer is not required to respond. If the IRS issues a no change report after an audit, the IRS generally cannot reopen the examination unless fraud or other similar misrepresentation is involved. If a taxpayer does not respond to the 30-day letter or does not reach agreement in the appeals process, a 90-day letter is issued.