Chapter 12 power point

Chapter 12Chapter 12Tax Administration & Tax Tax Administration & Tax

PlanningPlanning

Income Tax Fundamentals 2012

Gerald E. Whittenburg & Martha Altus-Buller

2012 Cengage Learning

Learning ObjectivesLearning Objectives

Identify organizational structure of the IRS Understand IRS audit process Define common penalties for taxpayers and

preparers Apply general rule for statute of limitations on tax

returns Describe rules that apply to practitioners and the

Taxpayer Bill of Rights Understand basic concepts of tax planning


Internal Revenue Service (IRS)Internal Revenue Service (IRS)

Congress creates tax law and the IRS is charged with enforcing 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


IRS Service CentersIRS Service Centers

Ten service centers located around country° Responsible for processing information from tax

documentsNational computing center located in

Martinsburg, WV° Information from various service centers is

matched with records from other service centers


IRS Restructuring Act of 1998IRS Restructuring Act of 1998

This act sought to structurally and operationally change the IRS by creating operating units along functional lines° Service & Enforcement arm collects taxes and

audits tax returns, including two factions:• 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

See Figure 12.1 on page 12-3 for complete IRS organizational chart


Examination of RecordsExamination of Records

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 if IRS summoning records from third parties!!


Back Tax Debt Payment Options Back Tax Debt Payment Options

IRS wants to help taxpayer work towards resolution and complianceo Can ask for short administrative extension of time

to pay debto Can pay in installments over timeo Can craft “offer in compromise” – used when it is

unlikely that taxpayer will ever pay debt in full

Note: IRS can also place lien on taxpayer’s

assets if debt is $10,000 or more


Selection of Returns for AuditsSelection of Returns for Audits Tax returns are selected for audit based upon a

multitude of factors ◦ Correspondence audit – handled by mail and usually involves

questions about W-2s/1099s, certain itemized deductions or the earned income credit

◦ 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), generally for taxpayers with substantial business activities

Note: Most common process for selecting returns for audit is based on statistical sampling, called DIF (Discriminant Function) score


Appeals ProcessAppeals Process

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

The IRS claims that through its recalibration process, fewer no-change audits are now conducted and larger assessments are levied

See Figures 12.2 and 12.3 on pages 12-8 and 12-9


InterestInterest IRS charges interest to the taxpayer for late taxes

◦ Interest paid is nondeductible consumer interest IRS pays interest to the taxpayer for refunds

◦ If the prior year’s 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 and is compounded daily for underpayment of taxes

Sample of recent rates:◦ First quarter 2011 3%◦ Second quarter 2011 4%◦ Third quarter 2011 4%◦ Fourth quarter 2011 3%


Failure to File PenaltiesFailure to File Penalties

If a tax return is not filed by its due date (with extensions), IRS will impose penalties◦ Penalty of 5% of tax is due per month or 15% if fraudulently

failing to file

◦ Limited to 25% in total (or 75% in total 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 return

The failure-to-file penalty is reduced by failure-to-pay penalty, if both penalties apply


Other PenaltiesOther Penalties

Failure-to-Pay Penalty is 0.5% of tax for each month tax late◦ Up to maximum penalty of 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 can be levied for negligence or disregard of rules or regulations

Note: If taxpayer can demonstrate reasonable cause for understatement of tax and that he/she acted in good faith, penalty will not be assessed


Fraud PenaltyFraud PenaltyFraud penalty is assessed for filing a

fraudulent tax returnCalculated 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◦ When the fraud penalty is assessed, the accuracy-

related penalty cannot be imposed

Note: If taxpayer can demonstrate reasonable cause for understatement of tax and that he/she acted in good faith, penalty will not be assessed


Other PenaltiesOther Penalties

Both civil and criminal penalties can be imposed for filing false withholding information

Also, assorted penalties foro Filing a frivolous tax return o Failing to file informational returns on a timely basis

(1099s, W-2s, etc)o Not depositing payroll taxes on a timely basiso Underpaying estimated taxeso Issuing a bad check for taxes


Statute of LimitationsStatute of Limitations

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

Exceptions to three year statute ◦No statute of limitations if it is a fraudulent tax return◦There is six year statute of limitations 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 7 years


Statute of LimitationsStatute of Limitations

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


Registered Tax Return PreparersRegistered Tax Return Preparers Beginning in 2011, preparers must register with IRS, pay a fee and

obtain a PTIN (prepared tax identification number)o These RTRPs must undergo a criminal background check and confirmation

that the preparer is current on his/her own tax filingso Preparers (with some exceptions) must pass a competency test and engage

in ongoing continuing education o 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 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

See pages12-16 and 12-17 for full list of preparer penalties


Burden of ProofBurden of Proof

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 (such as corporations, partnerships or estates with a net worth in excess of $7 million)


Tax Confidentiality PrivilegeTax Confidentiality Privilege

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


Taxpayer Bill of RightsTaxpayer Bill of Rights

Document addresses taxpayers rights Requires the IRS to inform taxpayers of their rights

and remedies when dealing with the Service◦ It provides remedies for resolving disputes with IRS◦ Has been amended several times since issuance

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 and 12-20 for Taxpayer Bill of Rights


Tax PlanningTax Planning Tax planning refers to arranging one’s financial affairs so

as to minimize tax liability There are two types of financial transactions

o In an “open” transaction, tax planning may still occur as transaction has not been culminated

o 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

Tax planning based on marginal tax rateo 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)

If illegal methods are used, this is called ‘tax evasion’


Finished!


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Chapter 12 power point