The document discusses the structure and responsibilities of the Internal Revenue Service (IRS). It covers how Congress creates tax law that the IRS enforces through departments that process tax documents, audit returns, and collect taxes owed. It also summarizes taxpayers' rights and responsibilities in dealing with audits, penalties for noncompliance, and the statute of limitations. Key aspects of tax preparation, tax planning and avoidance of "tax traps" are also addressed.

1. Income Tax Fundamentals 2010
Gerald E. Whittenburg &
Martha Altus-Buller
2010 Cengage Learning

2.  Congress creates tax law and the IRS
enforces it
◦ Includes assessment and collection departments
◦ Is a branch of the Treasury Department
◦ Is headquartered in Washington DC
 Commissioner of IRS is appointed by
president and approved by Congress
2010 Cengage Learning

3.  Ten service centers located around country
° Responsible for processing information from tax
documents
 National computing center located in
Martinsburg, WV
° Information from various service centers is
matched with records from other service centers
2010 Cengage Learning

4.  This act sought to structurally and
operationally change the IRS by creating
operating units along functional lines
° Service and Enforcement arm collects taxes and
audits tax returns
° Small Business/Self-Employed (SB/SE) unit
serves SB/SE customers
° Wages & Investment (W&I) division helps
taxpayers (that primarily pay taxes through
withholdings) comply with applicable laws
2010 Cengage Learning

5.  IRS has authority to examine taxpayers’
accounting records and books in a process
called an audit
 IRS can summon taxpayers and require
them to appear before the IRS and
produce necessary accounting records
◦ IRS may also summon taxpayer records from
third parties (CPAs, brokers, etc.)
◦ Taxpayer should enlist professional tax advice
2010 Cengage Learning

6.  Tax returns are selected for audit based
upon a multitude of factors
◦ Correspondence audit – handled by mail and
usually involves questions about W-2s and 1099s
◦ 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
◦ Field audit – conducted when records too
extensive to take to IRS office (usually involves
taxpayer engaged in business)
Note: Most common process for selecting returns for audit is
based on DIF (Discriminant Function) score
2010 Cengage Learning

7.  When tax return is selected for examination,
an agent is assigned
 There are three possible results from an
audit
◦ Agent determines that there are no changes
◦ Agent and taxpayer agree that there is a change in
tax liability
◦ Agent and taxpayer disagree on outcome
 In this scenario, taxpayer may appeal through
established appeals procedures
 See Figures 2 and 3
2010 Cengage Learning

8.  Interest is charged to taxpayer for late taxes
◦ Interest paid is nondeductible consumer interest
 Interest is paid to the taxpayer for refund
◦ Prior year audit reveals refund due
◦ Interest received from IRS is income
 Interest rate is adjusted quarterly based on the
short-term federal rate plus 3 percentage points,
sample of recent rates:
◦ First quarter 2009 5%
◦ Second quarter 2009 4%
◦ Third quarter 2009 4%
◦ Fourth quarter 2009 4%
2010 Cengage Learning

9.  If a tax return is not filed by its due date (with
extensions)
◦ Penalty of 5% of tax is due per month or 15% if
fraudulently failing to file
◦ Limited to 25% in total or 75% if fraudulent
◦ No penalty if no tax due or refund forthcoming
 If tax return is not filed within 60 days of due
date (with extensions), minimum penalty is:
◦ Lesser of $135 or
◦ Total amount of taxes due with tax return
 This penalty is reduced by failure to pay
penalty, if both penalties apply
2010 Cengage Learning

10.  Failure to Pay Penalty is 0.5% of tax for each
month tax late
◦ Maximum penalty is 25% of tax
◦ Increases to 1% per month 10 days after notice of
levy filed
◦ No penalty if there is no tax due or refund forthcoming
from IRS
 Accuracy-Related Penalty
◦ If calculations on tax return substantially understate
income tax or substantially overstate value of an
asset, penalty can be imposed
◦ Or for negligence or disregard of rules or regulations
2010 Cengage Learning

11.  Fraud penalty is assessed for filing a
fraudulent tax return
 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
◦ When the fraud penalty is assessed, the
accuracy-related penalty cannot be
imposed
2010 Cengage Learning

12.  Penalties, both civil and criminal, can be
imposed for filing false withholding information
 For filing a frivolous tax return
 For failing to file informational returns on a
timely basis (1099s, W-2s, etc)
 For not depositing payroll taxes on a timely
basis
 For underpaying estimated taxes
 For issuing a bad check for taxes
2010 Cengage Learning

13.  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
 Exceptions
◦ No statute of limitations if it is a fraudulent tax return
◦ Six years if amount of gross income omitted exceeds
25% of total gross income
◦ Statute of limitations for deduction of a bad debt or
worthless security is seven years
2010 Cengage Learning

14.  If IRS and taxpayer agree, Form 872 may be
signed that allows for extension of statute of
limitations
 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
2010 Cengage Learning

15.  The IRS does not prescribe any minimum
level of education for tax preparation
 Only CPAs, attorneys or enrolled agents
may represent clients at IRS proceedings
 There are a multitude of preparer penalties
◦ 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
2010 Cengage Learning

16.  In most civil tax cases the IRS has historically
placed burden of proof on taxpayer
 IRS Restructuring & Reform Act of 1998
changed tax law to shift burden of proof to IRS
in many cases
◦ Burden of proof automatically shifts to IRS in two
situations
 IRS uses statistics to reconstruct an individual’s income
 Court proceeding against an individual taxpayer involves
penalty/addition to tax
◦ In certain situations, burden of proof still rests with the
taxpayer
2010 Cengage Learning

17.  The attorney-client privilege has been extended
in limited circumstances to non-attorneys who
are authorized to practice in front of the IRS
◦ CPAs and enrolled agents
◦ This may be asserted only in a noncriminal tax
proceeding before the IRS or federal courts
◦ This privilege does not extend to written
communications between tax practitioner and a
corporation in connection with promotion of tax
shelter
 Does not automatically extend to state tax
situations
2010 Cengage Learning

18.  Document addresses taxpayers rights
 Requires the IRS to inform taxpayers of their
rights when dealing with the Service
◦ It provides remedies for resolving disputes with IRS
 Part I – Declaration of Taxpayer Rights
◦ Directs taxpayer to other IRS publications for more
details
 Part II –Examinations, Appeals, Collections &
Refunds
Note: See pages 12-19 – 12-20 for Taxpayer Bill of Rights
2010 Cengage Learning

19.  Tax planning refers to arranging one’s
financial affairs so as to minimize tax liability
 If illegal methods are use, this is called ‘tax
evasion’
2010 Cengage Learning

20.  Tax planning can help taxpayers avoid tax
traps
 Tax trap is a provision that can result in
the taxpayer’s loss of an otherwise
available tax benefit
◦ Watch for required deduction attributes like
reasonableness
2010 Cengage Learning

21. Finished!
2010 Cengage Learning