Chapter 12


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  • Chapter 12

    1. 1. Chapter 12 Tax Administration & Tax Planning Income Tax Fundamentals 2011 Gerald E. Whittenburg & Martha Altus-Buller 2011 Cengage Learning
    2. 2. Learning Objectives <ul><li>Identify organizational structure of the IRS </li></ul><ul><li>Understand IRS audit process </li></ul><ul><li>Define common penalties for taxpayers and preparers </li></ul><ul><li>Apply general rule for statute of limitations on tax returns </li></ul><ul><li>Describe rules that apply to tax practitioners and the Taxpayer Bill of Rights </li></ul><ul><li>Understand basic concepts of tax planning </li></ul>2011 Cengage Learning
    3. 3. Internal Revenue Service (IRS) <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>2011 Cengage Learning
    4. 4. IRS Service Centers <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>2011 Cengage Learning
    5. 5. IRS Restructuring Act of 1998 <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, including two factions: </li></ul></ul><ul><ul><ul><li>Small Business/Self-Employed (SB/SE) unit serves SB/SE customers </li></ul></ul></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></ul><ul><ul><li>See Figure 12.1 on page 12-3 for complete IRS organizational chart </li></ul></ul>2011 Cengage Learning
    6. 6. Examination of Records <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 if IRS </li></ul></ul><ul><ul><li>summoning records from third parties!! </li></ul></ul>2011 Cengage Learning
    7. 7. Selection of Returns for Audits <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/1099s, certain itemized deductions or the earned income credit </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), generally for taxpayers with substantial business activities </li></ul></ul><ul><ul><li>Note: Most common process for selecting returns for audit is based on statistical sampling, called DIF (Discriminant Function) score </li></ul></ul>2011 Cengage Learning
    8. 8. Appeals Process <ul><li>When tax return is selected for examination, an agent is assigned </li></ul><ul><li>There are 3 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><li>The IRS claims that through its recalibration process, fewer no-change audits are now conducted and larger assessments are levied </li></ul><ul><ul><ul><li>See Figures 12.2 and 12.3 on pages 12-8 and 12-9 </li></ul></ul></ul>2011 Cengage Learning
    9. 9. Interest <ul><li>IRS charges interest to the taxpayer for late taxes </li></ul><ul><ul><li>Interest paid is nondeductible consumer interest </li></ul></ul><ul><li>IRS pays interest to the taxpayer for refunds </li></ul><ul><ul><li>If the prior year’s 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 and is compounded daily for underpayment of taxes </li></ul><ul><li>Sample of recent rates: </li></ul><ul><ul><li>First quarter 2010 4% </li></ul></ul><ul><ul><li>Second quarter 2010 4% </li></ul></ul><ul><ul><li>Third quarter 2010 4% </li></ul></ul><ul><ul><li>Fourth quarter 2010 4% </li></ul></ul>2011 Cengage Learning
    10. 10. Failure to File Penalties <ul><li>If a tax return is not filed by its due date (with extensions), IRS will impose penalties </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% in total 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 total amount of taxes due with return </li></ul></ul><ul><li>The failure-to-file penalty is reduced by failure-to-pay penalty, if both penalties apply </li></ul>2011 Cengage Learning
    11. 11. Other Penalties <ul><li>Failure-to-Pay Penalty is 0.5% of tax for each month tax late </li></ul><ul><ul><li>Up to maximum penalty of 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 can be levied for negligence or disregard of rules or regulations </li></ul></ul><ul><ul><li>If taxpayer can demonstrate reasonable cause for understatement of tax and that he/she acted in good faith, penalty will not be assessed </li></ul></ul>2011 Cengage Learning
    12. 12. Fraud Penalty <ul><li>Fraud penalty is assessed for filing a fraudulent tax return </li></ul><ul><li>Calculated as 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><ul><ul><li>If taxpayer can demonstrate reasonable cause for understatement of tax and that he/she acted in good faith, penalty will not be assessed </li></ul></ul>2011 Cengage Learning
    13. 13. Other Penalties <ul><li>Both civil and criminal penalties can be imposed for filing false withholding information </li></ul><ul><li>Also, assorted penalties for </li></ul><ul><ul><li>Filing a frivolous tax return </li></ul></ul><ul><ul><li>Failing to file informational returns on a timely basis (1099s, W-2s, etc) </li></ul></ul><ul><ul><li>Not depositing payroll taxes on a timely basis </li></ul></ul><ul><ul><li>Underpaying estimated taxes </li></ul></ul><ul><ul><li>Issuing a bad check for taxes </li></ul></ul>2011 Cengage Learning
    14. 14. Statute of Limitations <ul><li>A taxpayer may not amend, nor may the IRS assess additional taxes, on a tax return for which the 3-year statute of limitations has expired </li></ul><ul><li>Exceptions to 3-year statute </li></ul><ul><ul><li>No statute of limitations if it is a fraudulent tax return </li></ul></ul><ul><ul><li>6-year statute of limitations 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 7 years </li></ul></ul>2011 Cengage Learning
    15. 15. Statute of Limitations <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>2011 Cengage Learning
    16. 16. Tax Practitioners <ul><li>The IRS will begin regulating paid preparers by requiring registration, competency exams and continuing education </li></ul><ul><ul><li>CPAs, enrolled agents, attorneys and all paid preparers will be required to register and pay fee if engaged in paid preparation after 12/31/10 </li></ul></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><ul><ul><li>See pages12-15 and 12-16 for full list of preparer penalties </li></ul></ul>2011 Cengage Learning
    17. 17. Burden of Proof <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 (such as corporations, partnerships or estates with a net worth in excess of $7 million). </li></ul></ul>2011 Cengage Learning
    18. 18. Tax Confidentiality Privilege <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>2011 Cengage Learning
    19. 19. Taxpayer Bill of Rights <ul><li>Document addresses taxpayers rights </li></ul><ul><li>Requires the IRS to inform taxpayers of their rights and remedies when dealing with the Service </li></ul><ul><ul><li>It provides remedies for resolving disputes with IRS </li></ul></ul><ul><ul><li>Has been amended several times since issuance </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 and 12-20 for Taxpayer Bill of Rights </li></ul>2011 Cengage Learning
    20. 20. Tax Planning <ul><li>Tax planning refers to arranging one’s financial affairs so as to minimize tax liability </li></ul><ul><li>There are two types of financial transactions </li></ul><ul><ul><li>In an “open” transaction, tax planning may still occur as transaction has not been culminated </li></ul></ul><ul><ul><li>In a “closed” transaction, tax consequences are already finalized and presentation to the IRS is limited to identifying facts in the most favorable light possible </li></ul></ul><ul><li>Tax planning based on marginal tax rate </li></ul><ul><ul><li>This is the rate applied to the “next dollar of income” or the “next dollar of deduction” and should be used when engaging in tax planning ( not the average tax rate) </li></ul></ul><ul><li>If illegal methods are used, this is called ‘tax evasion’ </li></ul>2011 Cengage Learning
    21. 21. Tax Traps <ul><li>A “tax trap” is a provision in tax law 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 or “ordinary and necessary” </li></ul></ul><ul><ul><li>Be aware of limitations such as at-risk loss limitations </li></ul></ul><ul><ul><li>Tax planning can help taxpayers avoid tax traps </li></ul></ul>2011 Cengage Learning
    22. 22. Finished! 2011 Cengage Learning