Chapter 18 - The Tax Compliance Process

Question 1

Which federal taxes are self assessed? 4

Answer 1

Income
Payroll
Self-Employment
Transfer

Question 2

What must every person do that has to pay or collect the self assessed taxes?

Answer 2

• Must compute the amount of tax due
• Fule the proper return
• Maintain adequate records supporting the calculations presented on the return.

Question 3

If an individual reports income on the basis of a calendar year when are they required to file their Form 1040 for the current year?

Answer 3

By April 15 of the following year

Question 4

If an individual has adopted a fiscal year when are they required to file their Form 1040 for the current year?

Answer 4

By the 15th day of the fourth month following the close of the taxable year.
Ex - Fiscal year July 1 - June 30 must file by October 15

Question 5

When must Corporations who file their taxes either on the basis of a calendar year or fiscal year file their taxes?

Answer 5

By the 15th day os the third month following the close of their taxable year.

Question 6

What form must individuals file for their taxes?

Answer 6

Form 1040

Question 7

What form must corporations file for their taxes?

Answer 7

Form 1120

Question 8

How long is the extension that individual and corporate tax payer may apply for to file their return?

Answer 8

6 months.

Question 9

What must taxpayers have to do to get an extension to file their tax return?

Answer 9

Submit an application for extension with the IRS. They are automatic, they do not have to explain why they want/need the extension.

Question 10

By what date must taxpayers submit their application for extension?

Answer 10

By the due date of their return.

Question 11

What does an automatic extension of time for filing a tax return NOT do?

Answer 11

Extend the time for payment of any tax due.

Question 12

If a taxpayer hasn’t finished his return by the original due date and needs an extension, how would they know what to pay the IRS in taxes owed that are due by the original due date.

Answer 12

They don’t know exactly, but must pay any estimated balance of tax due.

Question 13

When are taxes due?

Answer 13

By the UNEXTENDED due date of the return.

Question 14

What must taxpayers do that pay any amount of income tax after the required payment date do?

Answer 14

Pay the interest charged by the federal government.

Question 15

What is the interest that is charged on late payments of income tax charged by the federal government based on?

Answer 15

The number of days from the required payment date to the actual payment date.

Question 16

What is the Underpayment Rate?

Answer 16

Another name for the annual interest rate that is charged on income taxes paid past their original due date.

Question 17

How is Underpayment Rate calculated?

Answer 17

= (Federal Short-Term Rate) + 3% on amount of underpayment, compounded daily.

Question 18

How often is interest on underpayment of income taxes compounded?

Answer 18

Daily

Question 19

How often is the Federal Short Term Rate adjusted?

Answer 19

Quarterly.

Question 20

How is the underpayment rate for corporate underpayments exceeding $100,000 determined?

Answer 20

=(Federal Short-Term Rate) + 5%

Question 21

When is the IRS not required to pay interest on any income tax overpayment.

Answer 21

During the first 45 after the filing date of the return.

Question 22

What is the interest rate the government pays to individuals on overpayment who don’t received their refund within the given time? (i.e - How is it calculated)

Answer 22

= (Federal Short-Term Rate ) + 3%

Question 23

What is the interest rate paid on corporate overpayment of $10,000 or less? Greater than $10,000?

Answer 23

• (Federal Short-Term Rate) + 2%

- (Federal Short Term Rate) + 0.5%

Question 24

Who must pay a late-filing and late-payment penalty?

Answer 24

A taxpayer who fails to file an income tax return by the required due date and can’t provide a good excuse for such failure.

Question 25

What is the Late-Filing and Late Payment Penalty equal to?

Answer 25

5% of the balance of the tax due with the return for each month (or portion thereof) that the return is delinquent.

Question 26

What would the IRS waive if a taxpayer files his return later than due but can show reasonable cause for his tardiness? What won’t they waive.

Answer 26

The IRS may waive the penalty (Late-Filing and Late-Payment Penalty).
The will not waive the interest.

Question 27

What is the maximum time and % the 5% penalty can run for the Late-Filing and Late-Payment Penalty?

Answer 27

-5 months (until the penalty equals 25% of the balance due).

Question 28

After five months, what does the Late-Filing and Late-Payment Penalty rate drop to?

Answer 28

0.5% of the balance due.

Question 29

How long can the reduced rate of the Late-Filing and Late-Payment Penalty last?

Answer 29

An additional 45 months past the time the 5% rate ran for.

Question 30

Why when a taxpayer uses a tax preparer can they still be charged a late penalty if the tax preparer files the return late?

Answer 30

A taxpayer has an affirmative nondelegable duty to ensure the appropriate dorms–whether a tax return or an extension request–are actually filed by the statutory deadline.

Question 31

When can the government not charge a penalty on a return filed after the due date?

Answer 31

When it is found that the taxpayer is owed a refund.

Question 32

What are you doing in essence when you are due a refund but are late filing a return?

Answer 32

Giving the government an interest-free loan from the taxpayer that it does not need to repay until the taxpayer finally decides to file.

Question 33

What happens when a tax return arrives at one of the 10 IRS service centers?

Answer 33

They are checked for mathematical accuracy and logged into the IRS’s computer system.

Question 34

What happens to a return when it is input into the IRS’s computer system?

Answer 34

It is cross-checked against information returns filed with respect to the taxpayer, such as Form W-2s filed by employers; Form 1099s filed by payers of interest, dividends, rent, or other types of income; and Schedule K-1s filed by partnerships and S Corporations.

Question 35

What happens when a return reflects a math error or a discrepancy is found with an information return?

Answer 35

The service mails a letter to the taxpayer explaining the problem and calculating the additional tax or refund.

Question 36

Who/what is responsible for depositing checks or money orders with the U.S. Treasury and for authorizing refund checks to be mailed.?

Answer 36

The IRS Service Centers

Question 37

What do the facts of the government cashing a taxpayers tax check or mailing a refund signify? What do they not signify?

Answer 37

• They signify the return was processed.

- They do not signify that the IRS has accepted the accuracy of the return.

Question 38

What does the Statute of Limitations do for the IRS?

Answer 38

Gives them three years from the later of the original due date of the return or the date on which the return was actually filed to examine that return for mistakes and to assess any additional tax.

Question 39

What happens to the Statute of Limitations if a taxpayer files a return and omits an amount of gross income exceeding 25% of the gross income reported on the return?

Answer 39

The normal 3-year statute of limitations is extended to 6 years.

Question 40

How long does the Statute of Limitations last on a tax return that the IRS determines to be fraudulent?

Answer 40

The return remains open (subject to audit) indefinitely.

Question 41

How long should taxpayers keep all supporting paperwork such as receipts and canceled checks that relate to a tax return? Why?

Answer 41

• At least three years after the return is filed

- Because of the possibility of an audit.

Question 42

What records should be retained permanently? 3

Answer 42

• Records substantiating the tax basic of property
• Any legal document containing tax information (Divorce decree, closing statement on a property sale, etc)
• A copy of the tax return

Question 43

What is the primary way the IRS selects corporate tax returns for audit?

Answer 43

On the basis of the size of the business, measured in terms of taxable income and net worth as reported on Form 1120.

Question 44

How are individual tax returns selected for audit?

Answer 44

Based off the DIF score the return receives.

Question 45

What is a Discriminate Function System (DIF) score?

Answer 45

A numeric score assigned to individual tax returns that measures the return’s potential for generating additional tax on audit. The higher the score the higher the likelihood of an audit.

Question 46

What do tax practitioners assume to inflate a tax return’s DIF score?

Answer 46

• Highly speculative investment activities
• Unusually large itemized deductions
• Deductions that are prone to manipulation or abuse (Nonbusiness bad debts, travel and entertainment expenses, losses generated by a secondary business, etc)
• High income returns

Question 47

What are the three types of audits?

Answer 47

• Correspondence Examination
• Office Examination
• Field Examination

Question 48

What is a Correspondence Examination?

Answer 48

The simplest type of audit that can be handled by telephone or through mail. Usually very specific in scope.

Question 49

What is an Office Examination?

Answer 49

An audit conducted by a tax auditor at an IRS district office.

Question 50

What is a Field Examination

Answer 50

An audit conducted by a revenue agent at the taxpayer’s place of business.

Question 51

What do office audits focus on?

Answer 51

A few questionable items on a return.

Question 52

What do field audits focus on?

Answer 52

They are the broadest in scope and may involve a complete analysis of the taxpayer’s books and records for the year or years under investigation.

Question 53

What is an Enrolled Agent?

Answer 53

A person that receive certification to practice before the IRS by passing an exam on tax law written and administered by the IRS itself.

Question 54

Who can represent the taxpayer in an audit?

Answer 54

The Taxpayer
A lawyer
A CPA
An enrolled agent

Question 55

What is a deficiency?

Answer 55

The underpaid amount of tax based of a mistake on a return.

Question 56

Who may deduct interest paid on federal income tax deficiencies? Who may not?

Answer 56

Corporations may deduct it as a business expense.
An individual cannot, it is nondeductible personal interest “regardless of the source of the income generating the tax liability.”

Question 57

What is the Taxpayer Bill of Rights?

Answer 57

Enacted by Congress in 1989, it requires the IRS to deal with every citizen and resident in a fair, professional, prompt, and courteous manner and to provide the technical help needed by taxpayers to comply with the law. It ensures personal and financial confidentiality.
-It does have a disclaimer that it can share tax return information with state tax agencies., the Department of Justice, other federal agencies, and foreign governments under tax treaty provisions.

Question 58

What is IRS Publication 910?

Answer 58

A free booklet, Guide to Free Tax Services, is a catalog describing the many types of assistance offered.

Question 59

If the IRS requests information, what does the taxpayer have the right to know?

Answer 59

How the information will be used and the nature of any consequences if the taxpayer refuses to provide the information.

Question 60

What is the purpose of the office of National Taxpayer Advocate?

Answer 60

To assist taxpayers in resolving problems and to help taxpayers who suffer hardship because of IRS actions.
It heads a team of local Taxpayer Advocates who operate independently of the IRS’s audit, assessment, and collection functions.

Question 61

What does the Code use to attempt to discourage taxpayers from neglecting their legal responsibilities?

Answer 61

By imposing a variety of penalties.

Question 62

What is the IRS’s retaliation for the filing of a frivolous tax return?

Answer 62

$5,000 penalty.

Question 63

How is a frivolous tax return generally defined?

Answer 63

One that is blatantly incorrect or incomplete on the basis of a legal argument with absolutely no merit.

Question 64

When can the IRS impose a Negligent penalty? How is it calculated?

Answer 64

• When, during the course of an audit, a revenue agent may conclude that the taxpayer failed to make a reasonable attempt to prepare a correct return or intentionally disregarded the tax rules and regulations.
• 20% of any tax understatement attributable to the taxpayer’s negligent actions.

Question 65

What subjective factors does a person’s exposure to the negligence penalty depend upon? 4

Answer 65

• Complexity of the issue in question
• The individuals’s education and business experience.
• The existence of supporting documentation
• The individual’s degree of cooperation during the audit

Question 66

What is the burden of proof for that the IRS needs to present in court to charge a taxpayer with negligence?

Answer 66

Burden of production - Must present a preponderance of evidence (prove the facts and claims it asserted in the complaint) establishing negligence.

Question 67

What is the burden of proof for that the IRS needs to present in court to charge a taxpayer with civil fraud?

Answer 67

The IRS must show clear and convincing evidence.
(the evidence presented by a party during the trial must be highly and substantially more probable to be true than not and the trier of fact must have a firm belief or conviction in its factuality)

Question 68

What is the burden of proof for that the IRS needs to present in court to charge a taxpayer with criminal fraud?

Answer 68

Beyond a Reasonable Doubt (proof having been met if there is no plausible reason to believe otherwise)

Question 69

What is the harshest administrative penalty that the IRS may impose? How is it calculated?

Answer 69

• Civil Fraud

- 75% of the portion of a tax underpayment attributable to fraud.

Question 70

What is Civil Fraud?

Answer 70

The intent to cheat the government by deliberately understating tax. It is characterized by the systematic omission of substantial amounts of income from the tax return or by the deduction of nonexistence expenses or losses.

Question 71

What are some ways the IRS is alerted to fraud? 4

Answer 71

• Taxpayer keeps two sets of financial records, one for tax purposes and one reflecting the taxpayer’s true income.
• The taxpayer altered or destroyed business records and documents
• Taxpayer concealed assets
• Taxpayer cannot account for large cash receipts or deposits

Question 72

What is Criminal Fraud?

Answer 72

AKA - Tax Evasion. A particularly egregious incident of fraud.

Question 73

What happens when the IRS uncovers criminal fraud?

Answer 73

The IRS may turn the matter over to its Criminal Investigation Office.

Question 74

What is a Special Agent?

Answer 74

An agent assigned by the IRS’s Criminal Investigation office whose job it is to determine if the government has enough evidence to indict the taxpayer for criminal fraud.

Question 75

What is Tax Evasion? How is it punishable?

Answer 75

• A felony offense of tax fraud
• By monetary fines (up to $100,000 in the case of an individual and $500,000 in the case of a corporation) and by imprisonment in a federal penitentiary.

Question 76

Who is a Tax Return Preparer

Answer 76

ANY person who prepares returns (or employs other people to prepare returns) for COMPENSATION, regardless of whether the person is an attorney, CPA, or enrolled agent. They must make every effort to prepare accurate returns that report their clients’ correct tax.

Question 77

What are tax return preparers required to do? 4

Answer 77

• Sign the tax returns prepared for their clients
• Include their identifying number on such returns
• Furnish clients with copies of their completed returns
• Retain copies of all returns or a list of the names and identifying numbers of all clients.

Question 78

What are tax return preparers prohibited from doing?

Answer 78

Endorsing or negotiating tax refund checks.

Question 79

What is the penalty assessed to a tax return preparer who fails to sign a tax return?

Answer 79

$50 for each failure.

Question 80

What is the maximum penalty with respect to returns filed during any calendar year limited to?

Answer 80

$25,000

Question 81

What is the penalty assessed to a tax return preparer who takes an unreasonable legal position and that position results in an understatement of the clients’ tax liability.

Answer 81

The greater of $1,000 or 50% of the preparer’s compensation with respect to the return.

Question 82

How can a tax return prepared who takes an unreasonable legal position and that position results in an understatement of the clients’ tax liability avoid the penalty?

Answer 82

Demonstrate that there was a reasonable cause for the understatement and that the preparer was acting in good faith.

Question 83

What is the penalty assessed on tax return preparer when the IRS determines that they willfully understated a client’s tax liability or intentionally disregarded the tax law in preparing a return (willful and reckless conduct)?

Answer 83

The greater of $5,000 or 50% of the compensation for the return.

Question 84

What can a taxpayer do if they disagree with all or any part of the outcome of an audit (including penalties)?

Answer 84

• May appeal the disputed issue to the Appeals Office of the IRS.
• If there is failure to resolve the issues, the taxpayer can take the case to a federal court (U.S Tax Court, U.S. District Court, or U.S Court of Federal Claims) for judicial review.
• If they still don’t like the outcome they can appeal (1 appeal guaranteed) to the U.S Circuit Court of Appeals.
• If they still don’t agree, they can ask (not guaranteed to be heard) the U.S. Supreme Court to hear the case.

Question 85

What does a taxpayer’s appeal to the Appeals Office of the IRS lead to? What is the purpose?

Answer 85

• An administrative conference between the taxpayer (or more typically the taxpayer’s representative) and a specially trained IRS appeals officer.
• The purpose of the conference is to resolve the controversy in a fair and impartial manner.

Question 86

What can a taxpayer do who refuses to pay the deficiency determined by the IRS? What if they disagree put pay the deficiency?

Answer 86

• File a petition with the U.S Tax Court to hear the case.
• Pay and then immediately sue the government for a refund in either the local U.S. District Court or the U.S. Court of Federal Claims.

Question 87

What is the U.S. Tax Court?

Answer 87

• Courts that adjudicates only federal income, gift, and estate taxes issues
• Comprised of judges who are acknowledged experts in the tax law.

Question 88

What is the advantage of using the U.S. Tax Court?

Answer 88

They get judges that are tax expert and can be used to not only make determinations of fact, but determinations of law (interpret the law)

Question 89

What is the benefit of a taxpayer using the U.S. District Court?

Answer 89

They get a jury trial. Their peers may be sympathetic, being taxpayers themselves.

Question 90

Who pay appeal the verdict of the trial court to the U.S. Circuit Court of Appeals.

Answer 90

The losing party at the trial court.

Question 91

What differs about how the U.S Circuit Court of Appeals hears a case?

Answer 91

They generally do not review findings of fact by a lower court but instead will consider if the lower court properly applies the relevant law to the facts.

Question 92

What is it called when the U.S. Supreme Court agrees to hear a case? When it doesn’t?

Answer 92

• Grant Certiorari

- Deny Certiorari

Question 93

Who may appeal to have the case heard at the U.S. Supreme Court?

Answer 93

The losing party at the U.S Circuit Court of Appeals.

Question 94

What happens if the U.S Supreme Court denies certiorari?

Answer 94

The decision of the appellate court is final.

Question 95

Why would the U.S. Supreme Court agree to hear a case?

Answer 95

Either

• The case involves a significant principle of law, or
• Two or more appellate courts have rendered conflicting opinions on the proper resolution of the tax issue.

Question 96

What did Congress do make the legal system more accessible to the average person?

Answer 96

Established a Small Tax Case Division of the Tax Court.

Question 97

Who may use the Small Tax Case Division of the Tax Court? How does it work?

Answer 97

• A taxpayer who is disputing a deficiency of $50,000 or less.
• The taxpayer may request an informal hearing presided over by an officer of the court. The taxpayer may plead his own case without an attorney. The presiding officer, after hearing the case, renders judgement and the matter is settled–neither taxpayer nor government may appeal the case to any other court. Taxpayers who win may be entitled to recover litigation expenses from the government (court costs, attorney fees, fees paid to expert witnesses, and payments for technical studies, analyses, tests, and reports necessary for the case).

Question 98

When, after winning a case against the IRS, would a taxpayer not get back litigation related expenses?

Answer 98

If the IRS can convince the court that its position in the case was substantially justified.

Question 99

What does the Code authorize the Tax Court to do to a taxpayer who takes frivolous or groundless position before the court or institutes a case primarily for delay?

Answer 99

Impose a monetary penalty up to $25,000 on the taxpayer.

Question 100

What must taxpayers do who have exhausted every avenue of appeal do?

Answer 100

Must finally pay their tax deficiency (including interest and penalties) to the government.

Question 101

What is the IRS authorized to do to collect a tax deficiency?

Answer 101

• Seizing the taxpayer’s assets and selling them at auction
• Levying bank accounts
• Garnishing the taxpayer’s salary or wage.

Question 102

What is an Installment Agreement?

Answer 102

Requested by taxpayer who lacks the current resources to pay a tax bill, it provides for monthly payments over a reasonable period of time.

Question 103

How does the average installment agreement get approved? What are the terms

Answer 103

-For an individual that owes no more than $10,000, automatically, requiring full payment within three years, if the IRS determines that the individually is is financially unable to make immediate payment.

Question 104

What is an Offer In Compromise?

Answer 104

Used when the IRS determines that a taxpayer owing a deficiency’s financial condition is so bad it is unlikely that a tax bill will ever be paid it full, it is an acceptance of a lesser amount to settle the taxpayer’s bill. The goal os such is to collect the most feasible amount at the earliest possible time and at the least cost to the government.

Question 105

What is Transferee Liability?

Answer 105

-A liability of unsatisfied debts (including federal taxes) that was initially that of a corporation, that passed to the shareholders, that arises when the corporation no longer exists, to the extent of the value of any assets received on liquidation of the corporation.

Question 106

When does a person become liable for any tax deficiency with respect to that return?

Answer 106

When they (individuals) sign their Form 1040s.

Question 107

What is the liability for spouses in the case of a joint return?

Answer 107

Jointly and severally liable.

Question 108

What is the Innocent Spouse Rule?

Answer 108

When used, it relieves a person of liability when that liability is a real hardship on that person and they had signed the return without any knowledge of the information on the return.

Question 109

What three conditions does the relief from the Innocent Spouse Rule depend upon?

Answer 109

1. The deficiency must be attributable to erroneous items (such as omitted income or bogus
   deductions) of the person’s spouse.
2. The person must establish that in signing the return he or she did not know, and had no
   reason to know, that the return understated the correct tax.
3. Taking into account all the facts and circumstances, it is inequitable to hold the person liable for the deficiency.

Question 110

What is one factor that the court’s weigh very heavily upon in analyzing the condition of ‘Taking into account all the facts and circumstances, it is inequitable to hold the person liable for the deficiency.’ when deciding whether to use the innocent spouse rule? What is another?

Answer 110

• Whether the person significantly benefited, directly or indirectly, from any income omitted from the return.
• Whether the person seeking relief has been deserted by or is divorced from his or her spouse.