Chapter 12


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Chapter 12

  1. 1. Income Tax Fundamentals 2010 Gerald E. Whittenburg & Martha Altus-Buller 2010 Cengage Learning
  2. 2. <ul><li>Congress creates tax law and the IRS enforces it </li></ul><ul><ul><li>Includes assessment and collection departments </li></ul></ul><ul><ul><li>Is a branch of the Treasury Department </li></ul></ul><ul><ul><li>Is headquartered in Washington DC </li></ul></ul><ul><li>Commissioner of IRS is appointed by president and approved by Congress </li></ul>2010 Cengage Learning
  3. 3. <ul><li>Ten service centers located around country </li></ul><ul><ul><li>Responsible for processing information from tax documents </li></ul></ul><ul><li>National computing center located in Martinsburg, WV </li></ul><ul><ul><li>Information from various service centers is matched with records from other service centers </li></ul></ul>2010 Cengage Learning
  4. 4. <ul><li>This act sought to structurally and operationally change the IRS by creating operating units along functional lines </li></ul><ul><ul><li>Service and Enforcement arm collects taxes and audits tax returns </li></ul></ul><ul><ul><li>Small Business/Self-Employed (SB/SE) unit serves SB/SE customers </li></ul></ul><ul><ul><li>Wages & Investment (W&I) division helps taxpayers (that primarily pay taxes through withholdings) comply with applicable laws </li></ul></ul>2010 Cengage Learning
  5. 5. <ul><li>IRS has authority to examine taxpayers’ accounting records and books in a process called an audit </li></ul><ul><li>IRS can summon taxpayers and require them to appear before the IRS and produce necessary accounting records </li></ul><ul><ul><li>IRS may also summon taxpayer records from third parties (CPAs, brokers, etc.) </li></ul></ul><ul><ul><li>Taxpayer should enlist professional tax advice </li></ul></ul>2010 Cengage Learning
  6. 6. <ul><li>Tax returns are selected for audit based upon a multitude of factors </li></ul><ul><ul><li>Correspondence audit – handled by mail and usually involves questions about W-2s and 1099s </li></ul></ul><ul><ul><li>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 </li></ul></ul><ul><ul><li>Field audit – conducted when records too extensive to take to IRS office (usually involves taxpayer engaged in business) </li></ul></ul><ul><ul><li>Note: Most common process for selecting returns for audit is based on DIF (Discriminant Function) score </li></ul></ul>2010 Cengage Learning
  7. 7. <ul><li>When tax return is selected for examination, an agent is assigned </li></ul><ul><li>There are three possible results from an audit </li></ul><ul><ul><li>Agent determines that there are no changes </li></ul></ul><ul><ul><li>Agent and taxpayer agree that there is a change in tax liability </li></ul></ul><ul><ul><li>Agent and taxpayer disagree on outcome </li></ul></ul><ul><ul><ul><li>In this scenario, taxpayer may appeal through established appeals procedures </li></ul></ul></ul><ul><ul><ul><li>See Figures 2 and 3 </li></ul></ul></ul>2010 Cengage Learning
  8. 8. <ul><li>Interest is charged to taxpayer for late taxes </li></ul><ul><ul><li>Interest paid is nondeductible consumer interest </li></ul></ul><ul><li>Interest is paid to the taxpayer for refund </li></ul><ul><ul><li>Prior year audit reveals refund due </li></ul></ul><ul><ul><li>Interest received from IRS is income </li></ul></ul><ul><li>Interest rate is adjusted quarterly based on the short-term federal rate plus 3 percentage points , sample of recent rates: </li></ul><ul><ul><li>First quarter 2009 5% </li></ul></ul><ul><ul><li>Second quarter 2009 4% </li></ul></ul><ul><ul><li>Third quarter 2009 4% </li></ul></ul><ul><ul><li>Fourth quarter 2009 4% </li></ul></ul>2010 Cengage Learning
  9. 9. <ul><li>If a tax return is not filed by its due date (with extensions) </li></ul><ul><ul><li>Penalty of 5% of tax is due per month or 15% if fraudulently failing to file </li></ul></ul><ul><ul><li>Limited to 25% in total or 75% if fraudulent </li></ul></ul><ul><ul><li>No penalty if no tax due or refund forthcoming </li></ul></ul><ul><li>If tax return is not filed within 60 days of due date (with extensions), minimum penalty is: </li></ul><ul><ul><li>Lesser of $135 or </li></ul></ul><ul><ul><li>Total amount of taxes due with tax return </li></ul></ul><ul><li>This penalty is reduced by failure to pay penalty, if both penalties apply </li></ul>2010 Cengage Learning
  10. 10. <ul><li>Failure to Pay Penalty is 0.5% of tax for each month tax late </li></ul><ul><ul><li>Maximum penalty is 25% of tax </li></ul></ul><ul><ul><li>Increases to 1% per month 10 days after notice of levy filed </li></ul></ul><ul><ul><li>No penalty if there is no tax due or refund forthcoming from IRS </li></ul></ul><ul><li>Accuracy-Related Penalty </li></ul><ul><ul><li>If calculations on tax return substantially understate income tax or substantially overstate value of an asset, penalty can be imposed </li></ul></ul><ul><ul><li>Or for negligence or disregard of rules or regulations </li></ul></ul>2010 Cengage Learning
  11. 11. <ul><li>Fraud penalty is assessed for filing a fraudulent tax return </li></ul><ul><li>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 </li></ul><ul><ul><li>When the fraud penalty is assessed, the accuracy-related penalty cannot be imposed </li></ul></ul>2010 Cengage Learning
  12. 12. <ul><li>Penalties, both civil and criminal, can be imposed for filing false withholding information </li></ul><ul><li>For filing a frivolous tax return </li></ul><ul><li>For failing to file informational returns on a timely basis (1099s, W-2s, etc) </li></ul><ul><li>For not depositing payroll taxes on a timely basis </li></ul><ul><li>For underpaying estimated taxes </li></ul><ul><li>For issuing a bad check for taxes </li></ul>2010 Cengage Learning
  13. 13. <ul><li>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 </li></ul><ul><li>Exceptions </li></ul><ul><ul><li>No statute of limitations if it is a fraudulent tax return </li></ul></ul><ul><ul><li>Six years if amount of gross income omitted exceeds 25% of total gross income </li></ul></ul><ul><ul><li>Statute of limitations for deduction of a bad debt or worthless security is seven years </li></ul></ul>2010 Cengage Learning
  14. 14. <ul><li>If IRS and taxpayer agree, Form 872 may be signed that allows for extension of statute of limitations </li></ul><ul><li>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 </li></ul>2010 Cengage Learning
  15. 15. <ul><li>The IRS does not prescribe any minimum level of education for tax preparation </li></ul><ul><li>Only CPAs, attorneys or enrolled agents may represent clients at IRS proceedings </li></ul><ul><li>There are a multitude of preparer penalties </li></ul><ul><ul><li>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 </li></ul></ul>2010 Cengage Learning
  16. 16. <ul><li>In most civil tax cases the IRS has historically placed burden of proof on taxpayer </li></ul><ul><li>IRS Restructuring & Reform Act of 1998 changed tax law to shift burden of proof to IRS in many cases </li></ul><ul><ul><li>Burden of proof automatically shifts to IRS in two situations </li></ul></ul><ul><ul><ul><li>IRS uses statistics to reconstruct an individual’s income </li></ul></ul></ul><ul><ul><ul><li>Court proceeding against an individual taxpayer involves penalty/addition to tax </li></ul></ul></ul><ul><ul><li>In certain situations, burden of proof still rests with the taxpayer </li></ul></ul>2010 Cengage Learning
  17. 17. <ul><li>The attorney-client privilege has been extended in limited circumstances to non-attorneys who are authorized to practice in front of the IRS </li></ul><ul><ul><li>CPAs and enrolled agents </li></ul></ul><ul><ul><li>This may be asserted only in a noncriminal tax proceeding before the IRS or federal courts </li></ul></ul><ul><ul><li>This privilege does not extend to written communications between tax practitioner and a corporation in connection with promotion of tax shelter </li></ul></ul><ul><li>Does not automatically extend to state tax situations </li></ul>2010 Cengage Learning
  18. 18. <ul><li>Document addresses taxpayers rights </li></ul><ul><li>Requires the IRS to inform taxpayers of their rights when dealing with the Service </li></ul><ul><ul><li>It provides remedies for resolving disputes with IRS </li></ul></ul><ul><li>Part I – Declaration of Taxpayer Rights </li></ul><ul><ul><li>Directs taxpayer to other IRS publications for more details </li></ul></ul><ul><li>Part II –Examinations, Appeals, Collections & Refunds </li></ul><ul><li>Note: See pages 12-19 – 12-20 for Taxpayer Bill of Rights </li></ul>2010 Cengage Learning
  19. 19. <ul><li>Tax planning refers to arranging one’s financial affairs so as to minimize tax liability </li></ul><ul><li>If illegal methods are use, this is called ‘tax evasion’ </li></ul>2010 Cengage Learning
  20. 20. <ul><li>Tax planning can help taxpayers avoid tax traps </li></ul><ul><li>Tax trap is a provision that can result in the taxpayer’s loss of an otherwise available tax benefit </li></ul><ul><ul><li>Watch for required deduction attributes like reasonableness </li></ul></ul>2010 Cengage Learning
  21. 21. Finished! 2010 Cengage Learning