Federal Tax Research Ch 12

taxpayer civil penalties: false withholding/exemption info

$500 penalty

taxpayer civil penalties: filing a frivolous return - return takes positions that are meant to impede administration of tax law

$5000 penalty

organization of IRS

- IRS is a bureau w.i Dept of Treasury - Deputy Commissioner is CEO of IRS (appointed by President of US, renewable 5-yr term, responsible for planning + directing IRS policies + programs)

preparer conduct penalties

- endorsing or negotiating a refund check: $500 penalty - understatements due to unreasonable positions: greater of $1000 or 1/2 of fee received - willful understatement of tax liability: greater of $5000 or 1/2 of fee received - organizing abusive tax shelter: one that understates value of any property/service that exceeds 200% of correct amount, when pertaining to deduction or credit. Penalty is lesser of $1000 or 100% of income derived (aimed at tax shelter industry but tax advisers may be subject if help organize tax shelter projects) - aiding + abetting the understatement of tax liability: may be imposed in addition to other civil penalties, criminal penalties may apply - aiding + assisting in prep of false return: criminal penalty (imprisonment up to 3 yrs, up to $100k or $500k for corps) - disclosure or use of return info for other purposes: $250 civil penalty per occurrence, criminal penalties may also apply

summary of taxpayer civil penalties

- failure to file a tax return - failure to pay tax - accuracy-related penalty - civil fraud - failure to make estimated tax payments - failure to make deposits of taxes - giving false info w respect to withholding - filing a frivolous return

taxpayer criminal penalties

- intended to "prohibit and punish" fraud occurring in the assessment and collection of taxes - infrequently pursued - limited to cases where there's repetitive or egregious conduct and crime was committed in 3 prior years - not mutually exclusive of civil penalties - greater burden of proof on IRS to prove conduct was "beyond a shadow of any reasonable doubt"

reasons taxpayer may bypass appeal of 30 day letter

- new issues could be raised upon appeal by appellate officer - taxpayer may want to convey a firm conviction of the tax position - expedites conclusion of the issue

preliminary review of returns

- reviewed for simple/obvious errors - Automatic Data Processing (information document matching program, mathematical/clerical error program -- check returns for math errors and recomputes tax due) -Unallowable items program

criminal penalties: some successful defenses

- unreported income was offset by unreported deductions - unreported income was actually a gift - taxpayer confused or ignorant regarding applicable law - relied on erroneous advice of competent tax advisor - taxpayer had mental disease/defect - statute of limitations expired - taxpayer enters plea bargain and accepts conviction of lesser offense

criminal penalties: fines and/or imprisonment

- willful attempt to evade tax - willful failure to collect/remit tax - willful failure to file, supply info or pay est. tax - willfully making, subscribing or aiding and assisting fraud - willfully filing fraud info - disclosure or use of return info - penalties for individuals range from $1000 to $100,000 plus court costs: up to $500,000 for corps, imprisonment not to exceed 1-5 years

appeals process

-IRS encourages use of the appeals process -Appeals office has exclusive authority to settle cases w.i its jurisdiction -Appeals officer settles - supervised by IRS commissioner w input from chief counsel, may look at evidentiary issues, witness availability and credibility, and various arguments of law -Final opportunity to settle without incurring litigation costs -Utilizes appeals conference - an informal proceeding where dispute is discussed informally and appeals office utilizes personal judgment in deciding how to handle

conclusion of examination

-Revenue Agent's Report (RAR) prepared for taxpayer: documents case law, tax code that has been relied upon by IRS, proposed adjustments explained, lists tax balance due or in some cases to be refunded -Next steps if taxpayer disagrees with RAR: first ask for meeting with agent's supervisor, if no resolution from meeting - 30 day letter issued (appeal choices next to be considered) -Next step if taxpayer agrees with RAR: advance payment often made to avoid any additional accrual of interest and penalties since taxpayer agrees or can wait until 30-day letter received (preliminary notice of deficiency)

taxpayer may appeal a 30 day letter b/c

-appeals office can consider the hazards of litigation -possible settlement w.o litigation costs -delays payment of disputed tax -discover more details of gov'ts position -appeal sets taxpayer up to recover future possible court costs and attorney fees when case is litigated after appeal -expedites conclusion of the issue

selection of returns for examination

-discriminant function system (DIF) -national research program (NRP) -other selection methods

statutes of limitation

-once expired, taxpayer is no longer required to pay taxes that is rightfully owed -assessment must be made w/i 3 years of later of date return was field or unextend due date (extended to 6 years if taxpayer omits gross income more than 25% of reported gross income -- two exceptions, doesn't pertain to deductions that are overstated) -3 year assessment period is suspended w certain international transactions and foreign transfers -tax may be assessed at any time when a taxpayer files false or fraudulent return -filing amended returns does not affect length of the limitations period

estimated individual income tax payments

-penalty based on underpayment for each quarter and the applicable current interest rate - if "under withheld" tax = or > $1000 -safe harbor estimated payments for individuals: 1. 100% of PY tax reported on 12-month return (or 110% of PY where individual's AGI >$150,000) -- 75k if MFS 2. 90% CY tax 3. 90% tax based on annualized income

audit process

1. preliminary review of returns 2. selection of returns for examination 3. correspondence examinations, office examinations, field examinations 4. conclusion of examination

9 tax audit red flags for IRS

1. you filed a paper return 2. you claimed a home-office deduction 3. you received the EITC and/or have no adjusted gross income 4. you make more than $200,000 5. you make a laundry list of Schedule C losses 6. you claim too many business expenses 7. your charitable contributions are disproportionately high compared to your income 8. you failed to include Form 1099 income 9. your numbers look a little too perfect

taxpayer civil penalty: failure to make deposits of withheld employee taxes

2-15% of underpayment, depending on when failure is corrected, criminal penalties may also apply

accuracy-related penalties

20% of tax underpayment attributable to: - negligence or disregard of applicable federal tax rules and regs - substantial understatement of income tax - substantial valuation overstatement - substantial overstatement of pension liabilities - substantial understatement of estate and gift tax valuation - disallowance of claimed tax benefit - any undisclosed foreign-financial-asset understatement * can be assessed w audit or litigation even if original return shows no tax liability

accuracy-related penalty: valuation overstatement or understatement

20% valuation overstatement penalty - applies if valuation used is 150% of correct value, but N/A if related underpayment is equal to or less than $5000 ($10k for corps), 40% penalty if valuation used is 200% of correct value, commonly applied to charitable contributions. 20% valuation understatement penalty - applies if claimed value is 65% or less than correct value and the underpayment exceeds $5000, 40% penalty if claimed value is 40$ or less than correct value

after-tax cost of tax planning may be expressed as: ATC =

BTC x (1-MTR) ATC = After tax cost BTC = Before tax cost MTR = marginal tax rate

failure to file tax return

IRC 6651 - 5% of tax due per month (or fraction thereof), maximum of 25%, abated for reasonable cause if no willful neglect, if fraud asserted - 15% of tax per month to max of 75% - minimum penalty applies: if no return is filed w/i 60 days of due date (w ext.) the min fee = lesser of $205 or 10% tax due - avoid penalty by filing an ext. timely and filing return by extended due date

offers in compromise

IRS can settle civil or most criminal tax assessments...

Taxpayer Assistance Orders (TOA)

National Taxpayer Advocate may issue a TOA to suspend, delay, or stop actions by the IRS that would cause undue hardship on the taxpayer

avoiding tax traps

Statutory "tax traps": provisions in place intended to prevent certain planning opportunities Judicial tax traps: examine judicial decisions to find limits of code provisions - business purpose, substance over form, step-transaction doctrine, constructive receipt, assignment of income

injunction

a judicial order that prohibits the named person from practicing as TRP or engaging in specific activities, preparer must have: violated a preparer penalty or criminal provision of the IRC, misrepresented his/her eligibility to practice before the IRS, guaranteed payment of any tax refund or allowance of a credit, engaged in other fraudulent or deceptive conduct that substantially interferes w admin of tax laws

avoiding penalties - substantial authority

amount subject to penalty is reduced if taxpayer has substantial authority (primary authority + IRS info and press releases, IRS notices and announcements, letter rulings, TAM, general council memoranda, committee reports, "Blue Book" explanations of tax legislation)

interest

applied to the deficiency or tax due, federally specified rate (adjusted quarterly), compounded daily, computed on amount due from date of assessment (or due date of return), also computed on added civil penalties

accuracy-related penalty: substantial understatement of income tax

applies when - income tax understatement exceeds greater of 10% tax liability, or $5000 - corporate income tax understatement exceeds greater of 10% of tax liability or $10,000 - except if corporate income tax understatement exceeds $10m then penalty applies regardless of what % of tax is represented

taxpayer civil penalties

assessed when tax statutes are violated with reasonable cause, or as a result of negligence or fraud. Ad valorem penalties, assessable penalties

Tax Planning - avoid recognition of taxable income

avoid accumulation of gross income that must be recognized, use debt, use nontaxable fringe benefits in place of compensation

effective tax planning requires consideration for

both tax and non-tax factors

taxpayer penalties

can supplement revenues in a time when raising taxes is politically unpopular, increase tax cost of negotiating w Treasury and may discourage challenges to tax precedents, can bolster self-assessment process - tax pro must incorporate into his/her decision-making model the penalty-based costs of being too aggressive in taking certain positions

Tax Planning - Shifting

change tax jurisdictions to achieve tax reduction, tax planning among related taxpayers -- spread income among several separate businesses owned by individual and family members, payment of employee fringe benefits from solely-owned corporation - benefits deductible and not taxed to shareholder

Tax Planning - timing

change the timing of recognition of income, gains, deductions, losses, and credits. Postpone income recognition; accelerate losses and deductions (must consider present value of tax paid in later years)

field examinations

complex issues requiring revenue agents that have more knowledge and experience -IRS prefers to conduct on taxpayer premises - agent completely reviews entire financial operations of taxpayer - open-ended examination: agent free to pursue any unusual items in tax returns or records, reviews entire financial operations - book and records, tests gross receipts, reviews expense documentation

office examinations

conducted if examination involves one or more issues that will require some analysis -held at IRS district office - auditor given little time to prepare, scope limited to items on notification letter, taxpayer and/or representative bring records to office, individual returns w no business income, difficulty may lead to field exam -generally involve items like income from tips, rent and royalties, income from partnerships, deductions for travel/entertainment and deductions for bad debts and casualty/theft losses

fundamentals of tax planning

consider tax effects before transactions are finalized, pay attention to structural and transactional categories est. by Congress and the courts

organizational details of IRS National Office

deputy commissioner, wages + investment division (W+I), small business & self-employed (SB/SE) division, tax exempt + gov't entities (TEGE) division, large business + international division (LB+I)

tax planning includes

education planning, estate planning, retirement planning, income tax planning, investment planning, cash planning, risk planning

assessable penalties

flat dollar amount (note: assessable penalties are not reviewed by the Tax Court)

closing agreemets

formal, written binding agreement that enables both parties to finally and completely resolve tax controversy

civil fraud

if any part of underpayment is fraudulent, substantial civil penalty imposed. -75% of underpayment -burden of proof in fraud is on IRS - ex: 2 sets of books, making false accounting entries, destroying books or records, concealing assets or sources of income, consistently understating income or overstating deductions, avoiding making of business records and receipts

Taxpayer Advocate Service (TAS)

independent organization reporting directly to Commissioner through National Taxpayer Advocate for taxpayer intervention assistance (used to resolve billing, procedural, and other problems that taxpayers cannot correct after 1 or more contacts w/ IRS)

avoiding penalties - reasonable basis

makes full disclosure of position on Form 8275 or 8275-R

accuracy-related penalties: negligence

negligence = "any failure to make a reasonable attempt to comply w the provisions of the Code" -- penalty waived if good-faith attempt is made to comply w tax law w a FULL disclosure. negligence includes failure to keep adequate books + records, maintain substantiation, make reasonable attempt to determine correctness of deduction that is "too good to be true"

30 day letter

notifies taxpayer of proposed adjustments and appeals rights -taxpayer has 30 days from receipt to request conference with appeals office (written request required if tax and penalties < $25000, formal protest required to trigger the appeal where the tax and penalties >$10000) -if taxpayer doesn't respond to notice, receives statutory notice of deficiency (90 day letter) - issued by IRS next to trigger taxpayer's choice w/i those 90 days for a path to litigation

Tax Planning - change character of income

ordinary income is fully taxable, investment income may be tax-exempt or tax-deferred, passive income (tax shelters) can be netted with passive losses, LTCG are subject to lower rates than ordinary income

preparer disclosure penalties

penalties of $50 per occurrence for not giving taxpayer a copy of return, failure to sign tax return as preparer, no preparer ID # on return, failure to retain copy of tax return, failure to retain records fo employees, max $25,000 per year, per penalty

penalties on return preparers

penalties range from $50 to $1000, possible criminal penalties, Definition of Tax Return Preparer (TRP): one who prepares for compensation all or a substantial portion of a tax return or someone who employee preparers, list of functions that does not make a person a TRP, preparer disclosure penalties, preparer conduct penalties -substantial portion Safe Harbor: not substantial portion if schedule, entry, $ amounts are less than $10,000 or less than $400,000 and less than 20% of AGI

taxpayer civil penalties: reliance on written advice from IRS

penalty abated if relied on erroneous written advice from IRS specifically requested by taxpayer, not abated if advise error is due to taxpayer not providing all info

accuracy-related penalty: 40% underpayment of income tax penalty

penalty applies on ANY portion of an underpayment derived from one or more undisclosed transactions that: - lacks economic substance (IRC 7701) - fails to meet the requirements of any similar rule of law - foreign financial asset understatement

failure-to-pay penalty

penalty applies when taxpayer fails to pay tax owed on return without reasonable cause, when taxpayer fails to pay assessed deficiency w/i 10 days after notice and demand from IRS. 10 days becomes 21 days if assessment <$100,000 - penalty is 0.5% per month (or fraction thereof) up to max of 25%. equates to 50 months to reach max, assessed on net tax due at beg of month, increases to 1% after notice and demand from IRS, failure-to-pay % reduces the failure-to-file penalty when both apply

ad valorem penalties =

percentage of the delinquent tax

ex. of reasonable cause

possibly reliance on advice of competent tax counsel, return of timely mailed return without sufficient postage or mailed to incorrect IRS address, death/serious illness of taxpayer or immediate family, destruction of taxpayer's home-business-records by casualty, IRS issues: proper forms unavailable-erroneous info given, unavoidable absence or inability to obtain records needed

IRS mission statement

provide America's taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all

failure-to-pay penalty not applicable when

reasonable cause exists - there is a presumption of reasonable cause if additional tax due on return is < = 10% of total tax for the year -extension to file does not preclude failure-to-pay penalty

planning goal

reduce the net present value of the tax liability

relief from joint + several liability

relief from joint/several liability can be requested under IRC 6015 as follows: "innocent spouse" - if understatement (as contrasted to underpayment) of tax, allocation of liability between spouses, equitable relief - granted based on wide survey of facts + circumstances + abdicates taxpayer from underpayment or deficiency

taxpayer bill of rights guarantees

representation before the IRS, a recording of any proceeding, an IRS explanation of its tax position

local taxpayer advocates

responsible only to the National Taxpayer Advocate, resolve taxpayer problems and complaints

estimated corporate income tax payments

safe harbor estimated payments: 1. 100% of nonzero PY tax (12-month return) -- large corps (TI=$1 million or more for any of the 3 preceding tax years) may only use PY safe harbor for first-quarter estimate 2. 100% of CY tax 3. 100% tax based on seasonal or annualized methods - no penalty if tax due < $500

90 day letter

statutory notice of deficiency issued -when taxpayer and IRS cannot agree on proposed adj. after appeals conference -issued if taxpayer doesn't appeal w/i IRS process (must be sent before assessing proposed taxes, taxpayer has 90 days to pay tax and sue for a refund in US District Court of US Court of Federal Claims OR file a petition in tax court) -90 day period begin when it is mailed to the taxpayer's last known address in IRS records - unless there has been notification to commissioner of change in address, actual receipt of notice not required for 90 day period to begin, IRS docs sending the notice by certified or registered mail to document the actual mailing

collection and claims for refund/credit

taxes must be collected within 10 years after timely assessment, if tax is not collected administratively by levy, IRS must commence action in court before SoL expires. -claim for refund can be made by filing: Form 1040X (amended 1040), application for dentition refund - Form 1045 (indiv.) or Form 1139 (corps.), must be made within 3 years of date on which return was filed or two years of the date on which tax was paid.

entering judicial system

taxpayer has the right to select between Tax Court, pertinent district court, or US Court of Federal Claims. -strategies for choosing a court The Tax Court will review case if petition filed w court w.i 90 days after date of statutory notice of deficiency -district courts and Court of Federal Claims cannot hear case unless suing for refund

3 parties to every transaction

taxpayer, other party, and the government

accuracy-related penalties: disregard of rules

the "careless, reckless, or intentional disregard of Temporary or Final Regs, revenue rulings, or IRS notices"

effective tax planning maximizes

the taxpayer's after-tax wealth while achieving the taxpayer's non-tax goals

3 basic planning strategies

timing, income shifting, conversion

correspondence examinations

when one or two items on return questioned, can be done through correspondence -conducted by phone or mail (informal examination but same rights as office or field audits) -simple documentation issue usually involves verifying items by mailing copies of receipts or canceled checks

taxpayer has right to know

why IRS is requesting information, how IRS will use the information, repercussions of not providing info, and pertinent aspects of audit procedures