Chapter 2: Working With The Tax Law Flashcards
3 Primary Sources of tax law
- Statutory
- Administrative
- Judicial
16th Amendment
Amendment to the US constitution adopted on Feb 25th, 1913 that gave congress the power to lay and collect taxes on income
Accuracy-Related Penalty
A penalty of 20% of the underpayment amount imposed on taxpayers who file incorrect tax returns in certain situations
Determination Letter
A letter issued by a district director of the IRS advising a taxpayer on how to report a transaction for tax purposes
Discriminant Inventory Function System
A computer program used by the IRS in identifying tax returns for audit
Failure-to-file penalty
A penalty of 5% of the unpaid tax balance four each month or part thereof that a tax return is late; subject to a minimum penalty of $485 (in 2023) or 100% of the tax due if more than 60 days late
Failure-to-pay penalty
A penalty of 0.5% over month or part thereof that a taxpayer fails to pay tax that is owed
Final regulations
Regulations issued by the Treasury that have been adopted frankly after compliance with the requirements of the Administrative Procedures Act
Fraud
Implies that the taxpayer intentionally disregarded tax rules or misstated information included on the return
Interpretive Regulations
Official interpretations of the Internal Revenue Code by the treasury
Legislative regulations
Regulations in which the treasury determines the details of the law
Private letter ruling
Rulings issued by the IRS that are binding on the IRS only with respect to the transaction and the taxpayer that are the subject of the ruling
Procedural regulations
Housekeeping instructions indicating how the treasury and IRS will conduct their affairs
Proposed regulations
Regulations that have been drafted by the treasury, but have not yet been adopted
Revenue procedures
Statements issued by the IRS which detail internal practices and procedures within the IRS and make important announcements to taxpayers
Revenue rulings
Rulings issued by the IRS based on a set of facts common to many taxpayers and binding on the IRS
Statute of Limitations
Specified time within which the IRS may examine an income tax return
Substantial omission
An omission from a tax return of more than 25% of the gross income reported
Temporary Regulations
Regulations that have the same authority as final regulations and are issued when guidance must be provided quickly to taxpayers
Treasury regulations
Regulations that are official interpretations of the Internal Revenue Code and give taxpayers insight as to how the Code will be enforced by the IRS
US Court of Federal Claims
Court that may preside over tax controversies and only hears cases in Washington, DC
US District Court
Trial court of the federal judicial system which has general jurisdiction and is the only option for tax controversies in which the taxpayer would like a jury trial
US Tax Court
A special purpose court that sits in Washington DC and only hears tax cases. The judges within the court travel throughout the US to hear the cases
What do the 3 sources of tax law reflect
Reflect the structure of our political system
Administrative Source of Law
Treasury Regulations
- proposed regulations
- temporary regulations
- final regulations
Administrative Source of Law
IRS Determinations
- Revenue rulings
- private letter rulings
- determination letters
- revenue procedures
Admin Source of Tax Law
Revenue Rulings
Through the IRS
- based on facts common to many taxpayers & are issued to public to give taxpayers insight into how the IRS will treat certain transactions
- binding on the IRS
- courts are not bound by Revenue Rulings
- published weekly in the Internal Revenue Bulletin
- covers facts & applies to a large # of taxpayers
Taxpayers can:
* rely upon revenue rulings
* challenge the rulings in court
Admin Source of Tax Law
Private Letter Ruling
Through the IRS
- issued at the request of the individual taxpayer
- the IRS is bound by its determination in the ruling
- made available to the public
- cannot be relied on by other taxpayers as precedent (but may provide insight into IRS positions)
- a proposed transaction
- pursuasive evidence of how transactin will be treated for tax purposes
advantage of PLR is that the taxpayer can solicit advice from the IRS on tax consequences of a proposed transaction before the taxpayer enters into the transaction
Admin Source of Tax Law
Determination Letter
Through the IRS
- issued by District directors for returns files in their respective districts
- must be a completed transaction
- issued only if answer is covered specifically by:
- Statute
- Treasury decision or regulation
- ruling opinion or court decision published in the Internal Revenue Bulletin
Admin Source of Tax Law
Revenue Procedures
Through the IRS
- describe internal practices & procedures within the IRS
- published in the Internal Revenue Bulletin
- generally state changes in techniques and administrative procedures used by the IRS
make important announcements to taxpayers
Judicial Sources of Tax Law
Judicial Sources of Tax Law
- Courts:
- interpret statutory ambiguity
- cannot issue advisory opinions
- need “Case or Controversy”
court opinions are binding on lower courts, the IRS & taxpayers
what is the Administration of the Tax System
- managed by the IRS
- important issues:
- statute of limitations
- interest & penalties
- audits
- dispute resolution
what is the role of the Courts in our tax system
interpret ambiguous provisions of the Code & ensure that the laws enacted by Congress & enforced by the president are constitutional
when can a court review tax law
when a case or controversy exists between two parties (most likely between the taxpayer & IRS)
when considering the case of controversy presented, what can the court do exactly
can review the law that applies to the facts of the case & determine whether or not the regulation cited by the IRS is consistent with the intent of Congress or whether the law itself is constitutional
what happens when a court issues an opinion on a case or controversy brought before it?
that opinion becomes part of the body of the law
bc the courts have the obligation & duty to state what the law means
what happens once a court has entered its interpretation on a given case?
all lower courts in the same jurisdiction must comply with the opinion of the court
what happens once the US Supreme Court has ruled on an issue?
all US courts & the administrative branches of the government must comply with its decision
what is “Case Law”
the body of decisions from US courts
an important respurce for tax planning
admin of the tax system
Role of the IRS: what does the IRS do to fulfill its role
IRS receives & audits tax returns of individual taxpayers, & participates in the admin of the tax system by issuing:
- revenue rulings
- private letter rulings
- determination letters
- revenue procedures
admin of the tax system
Role of the IRS: who created the IRS & why
treasury department created the IRS to enforece the IRC & collect taxes imposed by Congress
admin of the tax system
General Statute of Limitations under Section 6501
under section 6501, the statute of limitations for IRS examination of income tax returns is generally 3 years from the date a tax return is filed
admin of the tax system
in order to have a cause of action against a taxpayer, what must the IRS do?
generally reveiw and contest the info submitted in the return with 3 years of the filing date
tax returns for a given year are typically filled when?
in the subsequent year
Statute of Limitations (in years)
substantial ommission or understatement of gross income of > 25%
may include understatement of basis for capital transactions
6 years
Statute of Limitations (in years)
Fraud
no limit
Statute of Limitations (in years)
in the event that the IRS assesses a tax deficiency on a taxpayer after auditing a tax return, what is the statute of limitations for collection of that deficiency?
10 years under section 6502
Statute of Limitations (in years)
refund claim by taxpayer, what is the statute of limitations?
3 years from date return is filed, or 2 years from date of tax payment (whichever is later)
Statute of Limitations (in years)
collection of erroneous refund by IRS to the taxpayer, the statute of limitations is what?
2 years; but it’s 5 years if induced by fraud
if a taxpayer commits fraud when filing their tax return, what happens to the statute of limitations?
it never closes
what does fraud imply
that the taxpayer intentionally disregarded tax rules or misstated info included on the return
what is the penalty for fraud
75% of any deficiency
statute of limitations (in years)
what happens if no tax return is filed by the taxpayer?
the statute of limitations under section 6511 is 2 years from the time the tax was paid
what is the normal 3 year statute of limitations process?
the stat of limit starts with the due date of the return, or the actual filing date of the return if the return was filed after the due date (without extensions)
a substantial omission of gross income on a tax return is considered to be how much
an omission of >25% of gross income reported on the tax return
Int & penalties for noncompliance
taxpayers who choose NOT TO COMPLY with the filing requirements are subject to a series of penalties such as:
- failure to file penalty
- failure to pay penalty
- accuracy related penalty
failure to file penalty
- 5% of the unpaid tax balance per month or part thereof that the tax return is late
- the max fail to file penalty is 25% of the unpaid balance (up to 5 months)
- if fraud is involved, its 15% per month and the max fail to file penalty is 75%
- if a tax return is filed more than 60 days late, the minimum fail to file penalty is the LOWER of $485 (in 2023) or 100% of the tax amount due
- reduced by failure to pay penalty
will stop accruing after 5 months
failure to pay penalty
if a taxpayer fails to pay the tax due on the due date
failure to pay penalty
- 0.5% per month or par therof that the balance due remains unpaid
- max fail to pay penalty is 25% of the tax liability
will continue to accrue for up to 50 months
what happens if a taxpayer is subject to BOTH the fail to file & fail to pay penalties?
the fail to file penalty is reduced by the fail to pay penalty for months in which they both apply
this creates a maximum potential 25% penalty for initial 5 months with the 0.5% per month fail to pay penalty continuing on for up to 45 additional months
Interest
- accrues from the due date of the tax return
- IRS will pay you interest on the refunds if you don’t receive your refunds within 45 days of filing or after april 15th?
penalties
- fail to file
- fail to pay
- accuracy related
- fraud
- underpayment of estimated tax
- negligence
causes of an accuracy related penalty
imposed on taxpayers who file incorrect returns as a result of:
- a failure to make a good faith effort to comply with the tax law
- a substantial understatement of tax liability (generally more than 10% of the correct tax liability & at least a $5,000 deficiency)
- a substantial valuation understatement
- a substantial estate or gift tax valuation understatement
accuracy related penalty
penalty imposed is generally 20% of the underpayment amount & can be increased to 30% for understatement of tax liability due to undisclosed listed transactions
undisclosed listed transactions: certain transactions listed by the IRS as tax shelter devices
fraud penalty amount
penalty of 75% of the underpayment of tax may be imposed
fraud penalty
frivolous or incomplete tax return penalty amount
$5,000 penalty regardless of tax liability
what can lead to a criminal offense
intentional actions constituting fraud or a willful failure tp file or pay the tax that is due
willfil failure to file an income tax return or pay the tax due can lead to what?
a misdemeanor carrying penalties of up to $25,000 ($100,000 in the case of a corporation) in fines and up to 1 year in prison, or both
what happens if there is a willful attempt to evade tax
its a felony, with fines up to $100,000 and jail sentences up to 5 years, or both
what happens if a taxpayer willfully files a false return
can be guilty of a felony, carrying a fine of up to $100,000 & jail sentences of up to 3 years, or both
what happens if a taxpayer underpays estimated taxes?
an underpayment of estimated tax penalty applies
when calculating the appropriate amount to pay each year, what is taken into account?
- income
- social security
- other taxes reported on an individual income tax return
estimated tax payments are not required if:
if a taxpayer has no tax liability for the prior year, was a US citizen or resident alien for the entire year, and the prior tax year covered a 12 month period
what happens if an individual owes tax liability at the end of the year
the IRS will impose two tests on that income to determine if a penalty is appropriate:
1) will check to see if the total amount of tax withholding & credits was at least 90% (66 1/3 % for farmers & fishermen) of the tax due for the year
* of the tax payments were <90%, a penalty will be imposed*
2) will check to see if the income tax withholding was at least 100% of the tax shown on the prior year tax return
* if it was, no penalty will be due
how can high income taxpayers (those with gross income over $150,000) avoid a tax penalty using the second test?
tax payments must have been at leat 110% of the prior year tax liability
the penalty that applies if the correct amount of tax payment has not been made is what
an interest charge on the underpayment
preparer penalties
Procedural penalties
failure to:
- provide copy of return
- sign as preparer
- keep copy
- maintain client list
preparer penalties
Statutory Penalties
- understatement due to unrealistic position
- willful attempt to understate tax
- failure to exercise due diligence - earned income credit, child tax credit, & American Opportunity tax credit
what is the mission of the IRS
provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities and enforce the alw with integrity and fairness to all
what is the primary purpose of an audit
to test whether or not the tax return filed by the taxpayer truthfully reflects their income and allowable deductions
discriminant Inventory function
- computer generated audit
- tax return (once filed) is checked against info sources reported to the IRS
- a high DIF score increases the likelihood that the return will be selected for audit
- if a return filed by a taxpayer includes items that are significantly different from the norm, or represents areas of known abuse, the computer will assign a high DIF score to the return
most common type of audit
Audits: methods of audits
- DIF (most common)
- related party
- targeted compliance
- subsequent claim for refund
- financial status
audits
Related party audit
occurs when the IRS audits a tax return of one individual and that indicuudal has claimed deductions for payments made to another person
auditsa
targeted compliance audits
result in checking tax returns of members of a particular profession (usually professions that have a high potential for engaging in tax evasino, such as cash-basis businesses) to test compliance with tax laws
audits
subsequent claims for refunds
even when a tax return was not selected for audit under any of the other audit methods, a sub claim for refund may prompt the IRS to take a closer look at the return due to fact the taxpayer didn’t carefully file their first tax return, resulting in the need to file an amended return or claim for refund
audits
financial status audit
look at the lifestyle of the taxpayer to determine if the income reported on the taxpayers tax return is sufficient to fund their current lifestyle
audits
lifestyle audits
typically used with high profile criminal cases when criminals don’t report high income, yet live lavishly
audits
what happens when you’re selected for audit
an income tax report will be examined by the IRS, and adjustments will be made to correct the tax liability for the taxpayer consistent with the perspective of the IRS
if the taxpayer doesn’t agree with the findings in the audit, the dispute resolution process between the IRS & the taxpayer will begin
dispute resolution
if the taxpayer doesn’t agree with the findings in the audit, the dispute resolution process between the IRS & the taxpayer will begin
dispute resolutions can take two forms
- internal appeals process
- use of the US court system
dispute resolution process
- examination
- 30 day letter
- taxpayer can appeal to IRS appeals office within 30 days
- IRS appeals office si separate from examination division
- if no internal appeal, a 90 day letter issued (Notice of Deficiency)
- taxpayer has 90 days to:
- pay or
- file a petition in tax court without first paying the tax, or
- pay tax and file suit in District Court or the US Court of Federal Claims
- taxpayer has 90 days to:
Appellate Courts
- US Court of Appeals (Regional Circuit)
- US Court of Appeals (Federal Circuit)
Trial courts (courts of original jurisdiction)
- US Tax Court
- Small case division
- US District Court
- US Federal Claims
US Tax Court
- no payment of tax is necessary to bring a claim before the US Tax Court
- No trial by jury is available
- the Small Tax Case Division handles deficiencies under $50,000 at the taxpayers request
- informal procedures, no appeal rights
- Tax Court decisions do NOT bind the IRS with respect to other taxpayers
- appeals are to the US Court of Appeals
- only handles tax cases
- no prepayment of tax
- no trial by jury
- has small case division under it
- appeals to US Court of Appeals
Small Tax Case Division under the US Tax Court
- no appeals
- only handles tax cases
- handles deficiencies under $50,000 at the taxpayers request
- no trial by jury
- no prepayment of tax
- may have either an Attorney, CPA or Enrolled Agend represent a claim during and audit by the IRS
- a CFP may not represent a client during an IRS audit
who may represent a client in front of the IRS during an audit by the IRS
A,C,E
Attorney, CPA or Enrolled Agent
CFP NOT Allowed
US District Court
- tax deficiencies must be paid to proceed in this forum
- is the only forum which allows a trial by jury
- is bound by decisions of both the US Appeals Court (Regional Circuit) & Supreme Court
- handles all types of cases
- preypayment of tax
- trial by jury
- appeal to US Court of Appeals (Regional Circuit)
US Court of Federal Claims
- sits only in Washington DC
- tax deficiencies must be paid to proceed in this forum
- appeals are to the US Court of Appeals for the Federal Circuit
- prepayment of tax
- no trial by jury
- appeal to US Court of Appeals (Federal Circuit)
US Court of Appeals
- 12 circuit courts in the US
- handles appeals from Tax Court & District Court
- Court of appeals in one ciruit is not bound to follow the decisions of the court of appeals in another circuit
US Supreme Court
- decisions are binding on taxpayers and the IRS
- reviews tax cases if:
- there is a conflict between the circuit courts
- an important and recurring problem in tax law administration is involved
- many taxpayers are involved
- decision of a lower court conflicts with long standing practice of the regulations
US Court System Summary
Tax Research
Primary Sources
- Internal Revenue Code (IRC)
- Treasury Regulations
- IRS Rulings
- IRS Manual
- Court Opinions
- free sources on the internet
- sources of tax law ae used by: attorneys and accountants, but may be helpful to other tax pros too
Tax Research
Secondary Sources
- Research Institute of America (RIA)
- Commerce Clearing House (CCH)
- Bloomberg BNA (BNA)
- accessed for a fee
Tax Research
Periodical Sources
- Federal Tax Articles (CCH)
- Journal of Taxation
- Tax Notes
- Monthly digest of tax articles
- journal of the Society of Financial Services Professionals
- Estate Planning
- Trusts & Estates
- Journal of Financial Planning
Tax Research
Sources to keep up to date with new tax developments
- CCH & RIA
- accounting firm websites
- TaxProTalk.com (formerly Tax Almanac)
- The Daily Tax Report, published by the Bureau of National Affairs
- LexisNexis & Westlaw
- IRS.gov
what sources of tax law may NOT be relied upon by a taxpayer for legal precedence?
Proposed Regulations & Private Letter Rulings
What sources of tax law MAY BE RELIED UPON by a taxpayer for legal precedence?
Revenue Rulings & Temporary Regulations
what may be cited as a precedent?
regulations, temporary regulations & US Tax Court decisions
federal tax legislation generally originates in what body?
House Ways & Means Committee
Issued when the Treasury feels that guidance must be provided quickly to taxpayers
Temporary Regulations
A characteristic of the statute of limitations is:
A different statute of limitations applies to tax refunds and deficiencies
Based on a set of facts that are common to many taxpayers to provide insight how the IRS will treat certain transactions?
Revenue Rulings
Does not allow the Taxpayer to appeal the decision
Small Claims Division
with respect to the U.S. Tax Court, what can they do?
- They issue both Regular and Memorandum decisions.
- The IRS may acquiesce to its decision.
- A taxpayer does not have to pay the deficiency before litigating in this court
- No jury trial is available
It details internal practices and procedures within the IRS?
Revenue Procedures
Issued at the request of an individual taxpayer
Private Letter Rulings
Have been drafted by the Treasury, but have not yet been adopted?
Proposed Regulations
Requested from a district director of the IRS when the taxpayer has already engaged in a transaction?
Determination Letter
Began as proposed or temp regulations and have the full force and effect of law?
Final Regulations
Only holds court in Washington DC?
US Court of Federal Claims
Does not require the Taxpayer to pay the tax before filing suit?
Small Claims Division & the US Tax Court
characteristic of the statute of limitations is:
A different statute of limitations applies to tax refunds and deficiencies
