I. Federal Tax Practice and Procedures

Question 1

6. Substantiation and Disclosure of Tax Positions

The IRC imposes (in Section 6662) a 20% penalty on various types of underpayments, including:

Answer 1

A. Underpayments attributable to negligence or disregard of rules or regulations.

B. Any substantial understatement of income tax.

1. An “understatement” in this category is reduced by the amount attributable to any item where:
   a. The relevant facts affecting the tax treatment are adequately disclosed (typically on a Form 8275 or 8275R), and
   b. There is a “reasonable basis” (≥20% chance of being sustained) for the tax treatment.
2. Disclosure is important here because an undisclosed position must be supported by “substantial authority,” which requires a ≥40% chance of being sustained.

Question 2

6. Substantiation and Disclosure of Tax Positions

Fitely hired a tax accountant whom his attorney recommended. The accountant, Tilder, recommended that Fitely take a particular tax position that resulted in an understatement of taxes and the IRS is now seeking to penalize Fitely. In order to establish a good faith defense against the 20% understatement penalty, which of the following does Fitely need to establish:

Answer 2

A. That Tilder was a competent professional.

B. That Fitely gave Tilder all necessary and accurate information.

C. That Fitely actually relied in good faith on Tilder’s judgment.

D. All of the above.

Choice D: Correct! All choices are needed to establish the good faith defense.

Question 3

7. Taxpayer Penalties

B. Any Substantial Understatement of Income Tax(the penalty is 20% of the underpayment)

1.For individuals, a “substantial understatement” is one that exceeds the greater of:

Answer 3

a. 10% of the tax, or
b. $5,000.

Example

Ted’s correct tax amount is $10,000, but Ted reported only $6,000. Ted’s understatement of $4,000 is less than the greater of the two standards ($5,000) and therefore is not a “substantial understatement.”

CF.
1. A tax return preparer, who prepares a return or refund claim, which includes an “unreasonable position,” must pay a penalty of the greater of $1,000 or 50% of the income derived by the preparer for preparing the return (50% × $1,000 = $500). A position is unreasonable if there is not substantial authority for it. There is an exception to this rule if the position was disclosed and there is a reasonable basis for it.

2. If the understated tax liability is due to an unreasonable position and the preparer willfully attempts to understate the tax liability or recklessly or intentionally disregards rules or regulations, the penalty is the greater of $5,000 or 75% of the income earned by the tax preparer for preparing the return or claim (75% × $1,000 = $750).
3. Monica will have no penalty. If a preparer takes a position on a return that understates the true tax liability, the preparer will not be subject to a penalty if the position taken has substantial authority. However, if the position is disclosed on the return on Form 8275, then no penalty is assessed as long as there is a reasonable basis for the position.

Question 4

7. Taxpayer Penalties

B. Any Substantial Understatement of Income Tax

2. For non–Subchapter S corporations, a “substantial understatement” is one that exceeds the lesser of:

Answer 4

a. 10% of the tax (or, if greater, $10,000), or
b. $10 million.

Example

ABC Corporation’s correct tax amount is $100,000, but it reported only $60,000. ABC’s understatement is $40,000. That understatement does not exceed $10 million, but it does exceed the lesser standard of 10% of the tax ($10,000), which in this instance is equal to $10,000. Therefore, this is a “substantial understatement.”

Question 5

7. Taxpayer Penalties

Reasonable Cause and Good Faith Defense (Section 6664)

Reasonable Cause

1. Definition—The exercise of ordinary business care and prudence
2. Judged objectively
3. Belief requirement for reasonable cause related to tax positions:

Answer 5

a. Undisclosed position—“Substantial authority” (≥40% chance)
b. Disclosed position—“Reasonable basis” (≥ 20% chance)
c. Tax shelter position—“More likely than not” (>50% chance)

Question 6

7. Taxpayer Penalties

Good Faith

1. Definition—Honesty of purpose.
2. Judged subjectively.

Question 7

8. Sources of Tax Authority and Research
9. Types of Tax Authority

Answer 7

1) Primary authority: original sources of the law
2) Secondary authority: commentary on tax law(treatises, journals, and commentaries by editorial services)

Question 8

8. Sources of Tax Authority and Research

Primary authority comes from each of the three branches of the federal government;

Answer 8

1. Legislative authority (Authority from Congress)
2. Administrative authority (Authority from the Treasury Department and Internal Revenue Service)
3. Judicial authority

Question 9

8. Sources of Tax Authority and Research
9. Legislative authority (Authority from Congress)

Sources of statutory authority include:

Answer 9

1. The Constitution, as all tax laws, must be consistent with the provisions of the Constitution such as the 16th Amendment authorizing an income tax
2. Internal Revenue Code Statutes (cited as IRC §351)
3. Treaties
4. Committee Reports of

House Ways and Means Committee,

Senate Finance Committee,

Joint Conference Committee

Question 10

8. Sources of Tax Authority and Research
9. Administrative Authority (Authority from the Treasury Department and Internal Revenue Service)

pronouncements issued by IRS;

A. Treasury Regulations (can be classified as;

Answer 10

a. Legislative (almost like the statute(IRC))
b. Interpretative (written under the general mandate given to Treasury to develop regulations to interpret the laws legislated by Congress.
c. Procedural (process for submission)

Question 11

8. Sources of Tax Authority and Research
9. Administrative Authority (Authority from the Treasury Department and Internal Revenue Service)

pronouncements issued by IRS;

A. Treasury Regulations (can also be classified as;

Answer 11

a. Proposed—Regulations must be issued as proposed regulations for at least 30 days before becoming final, although they may exist in a proposed form for many years. Proposed regulations do not have the effect of law, but they do provide an indication of the IRS’s view on a tax issue.
b. Temporary—These regulations do have the effect of law but only for three years. Temporary regulations are usually issued when taxpayers need immediate guidance on a substantive matter of the law.
c. Final regulations—Proposed or temporary regulations can later be issued as final regulations which have the effect of law until revoked.

Question 12

8. Sources of Tax Authority and Research
9. Administrative Authority (Authority from the Treasury Department and Internal Revenue Service)

pronouncements issued by IRS;

B. Revenue Rulings—(Rev. Rul. 2009-12)

Answer 12

1. Do not have as much weight as regulations
2. Are limited to a given set of facts
3. Deal with more specific issues than regulations

Question 13

8. Sources of Tax Authority and Research
9. Administrative Authority (Authority from the Treasury Department and Internal Revenue Service)

pronouncements issued by IRS;

C. Private Letter Rulings—(PLR 200948009)

Answer 13

1. Request by the taxpayer for the IRS to provide the tax consequences on a specific set of facts
2. Transaction cannot have been completed by the taxpayer for the request to be made.
3. Precedent applies only to the taxpayer making the request. However, PLRs can be used by other taxpayers to establish “substantial authority” for penalty purposes.
4. IRS does not have to provide a ruling on the request.

Question 14

8. Sources of Tax Authority and Research
9. Administrative Authority (Authority from the Treasury Department and Internal Revenue Service)

pronouncements issued by IRS;

Answer 14

D. Revenue Procedures (Rev. Proc. 2008-23)—These provide internal management practices of the IRS.

E. Technical Advice Memoranda—(TAM 201003016)—These are requested by the IRS field agents during an audit. They apply only to the affected taxpayer.

F. Other sources of authority include notices, announcements, and general council memoranda.

Question 15

8. Sources of Tax Authority and Research
9. Judicial Authority

A. Courts of Original Jurisdiction

Any tax dispute not resolved between the taxpayer and the IRS that goes to court must begin in a court of original jurisdiction.

Answer 15

1. U.S. Tax Court
2. U.S. District Courts
3. U.S. Court of Federal Claims
4. U.S. Tax Court - Small Cases Division

Question 16

8. Sources of Tax Authority and Research
9. Judicial Authority

A. Courts of Original Jurisdiction

1. U.S. Tax Court

Answer 16

a. Hears only tax cases
b. One court, but the 19 judges travel in smaller groups throughout the country to hear cases. For certain issues all judges may hear the case.
c. Taxpayer does not have to pay deficiency before trial as long as a petition is filed in a timely manner.
d. Jury trial is not available.
e. The IRS has adopted an acquiescence policy for regular Tax Court decisions that it loses. Acquiescence indicates that the IRS will follow the decision in future situations, involving similar facts and issues. Nonacquiescence indicates that the IRS will not follow the decision and can be expected to litigate in situations involving similar facts and issues.
f. Decisions of the Tax Court are appealed to U.S. Court of Appeals. As a matter of policy known as the Golsen Rule, the Tax Court will follow the law of the circuit to which a case is appealable.

Question 17

8. Sources of Tax Authority and Research
9. Judicial Authority

A. Courts of Original Jurisdiction

2. U.S. District Courts

Answer 17

a. Jury trial is possible.
b. Must pay deficiency first and then sue the IRS for a refund
c. Judges are not tax specialists since all types of legal matters are tried.
d. Many different district courts throughout the country

Question 18

8. Sources of Tax Authority and Research
9. Judicial Authority

A. Courts of Original Jurisdiction

3. U.S. Court of Federal Claims

Answer 18

a. There is only one court in Washington, D.C.
b. Must pay deficiency first and then sue the IRS for a refund
c. 16 judges, who are not tax specialists, since all types of legal matters are tried
d. Jury trial is not available.

Question 19

8. Sources of Tax Authority and Research
9. Judicial Authority

A. Courts of Original Jurisdiction

4. U.S. Tax Court—Small Cases Division

Answer 19

a. $50,000 or less
b. No appeal

Question 20

8. Sources of Tax Authority and Research
9. Judicial Authority

A. Courts of Original Jurisdiction

B. Appellate Courts

Answer 20

1. U.S. Court of Appeals
   a. Hears appeals from Tax Court and District Court.
   b. 11 circuits plus the District of Columbia Circuit.
   c. District court must follow the decision/precedent of the Circuit Court of Appeals for the circuit in which the District Court is located.
   d. Tax Court will follow previous decisions in the Circuit that will have jurisdiction on appeal (Golsen rule).
2. U.S. Court of Appeals for the Federal Circuit—Hears appeals from the U.S. Court of Federal Claims.

Question 21

8. Sources of Tax Authority and Research
9. Judicial Authority

A. Courts of Original Jurisdiction

B. Appellate Courts

C. U.S. Supreme Court

Answer 21

1. Hears very few tax cases
2. Highest court in the United States

Question 22

9. Tax Practice and Procedure
   1) Audit Process

Answer 22

M. If agreement is not reached through the audit process, the taxpayer will receive a copy of the RAR(Revenue Agent’s Report) and a 30-day letter.

N. The IRS encourages the taxpayer to agree to the RAR or request an appellate conference. However, the taxpayer is not required to respond.

Question 23

9. Tax Practice and Procedure
   2) Appeals Process

Answer 23

A. To appeal, a written protest must be filed with the request for an appellate conference.

C. The IRS is not required to grant an appeal in all cases.

E. The appellate conference itself is informal when contrasted to a judicial proceeding.

G. If a taxpayer does not respond to the 30-day letter or does not reach agreement in the appeals process, a 90-day letter is issued.

H. The 90-day letter is significant in that this is the time that the taxpayer has to file a petition with the Tax Court. If the petition is not filed in a timely manner, the taxpayer’s only judicial recourse is through a U.S. District Court or a U.S. Claims Court, both of which require the deficiency to be paid before the judicial process can begin.

I. Once a petition has been filed with the Tax Court, the IRS cannot issue a notice of deficiency until the court’s decision in the matter has been finalized.

Question 24

9. Tax Practice and Procedure
   3) Other Practice Issues

Answer 24

A. An offer in compromise may be agreed to by the IRS, which allows a taxpayer to settle a tax liability for less than the actual amount owed.

Question 25

9. Tax Practice and Procedure

Documents govern the conduct of a CPA who is engaged in providing tax services

Answer 25

A. AICPA’s Code of Professional Conduct

B. AICPA’s Statements on Standards for Tax Services

C. Circular 230

Question 26

10. Compliance Responsibilities
11. Filing Requirements

Answer 26

• One is considered 65 on the day before his or her 65th birthday
• Alvin files as married filing jointly and is age 67. His wife is 59 years old; 24,400 + 1,300

Question 27

10. Compliance Responsibilities
11. Penalties

A. Nonfiling Penalty

Answer 27

1. The penalty for late filing is 5% per month (or a portion thereof) of the tax due with the return.
2. The maximum penalty is 25% of the tax due, and the minimum penalty (due if return is not filed within 60 days of the due date) is the lesser of $215 (2019) or the amount of the tax due. If the minimum tax applies and is greater than the maximum tax, then the minimum tax must be paid.
3. If the failure to file is fraudulent (intentional), the penalty is increased to 15% per month up to a maximum of 75% of the tax due with the return.

Question 28

10. Compliance Responsibilities
11. Penalties

B. Underpayment Penalty

Answer 28

1. Required tax payments for individuals
   c. No penalty is imposed if the tax payments during the year were:
   i. At least 90% of current year taxes (this has been reduced to 85% just for estimated payments for the 2018 tax year), or
   ii. 100% of last year’s taxes. If the taxpayer’s AGI exceeds $150,000, then tax payments during the year must be at least 110% of last year’s taxes.
2. Required corporate tax payments
   b. There is no estimated tax underpayment penalty if the payments are at least equal to the lower of:
   i. 100% of current year’s tax, or
   ii. 100% of the preceding year’s tax.
   iii. The penalty can also be avoided if the annualization exception is met.
   * To avoid an underpayment penalty, the corporation can pay the lower of 100% of the prior year’s tax liability ($40,000) or 100% of the current year’s tax liability ($48,000).*

Question 29

10. Compliance Responsibilities
11. Preparer Penalties

Answer 29

A tax return preparer who prepares a return or refund claim that includes an unreasonable position must pay a penalty of the greater of $1,000 or 50% of the income derived by the preparer for preparing the return.

Question 30

10. Compliance Responsibilities

Definition

Unreasonable Position:

Answer 30

A position is unreasonable if it does not have substantial authority.

Substantial authority generally means that the taxpayer has at least a 40% chance of winning if the IRS challenges the position in court.

Question 31

10. Compliance Responsibilities

Tax preparers are subject to civil penalty for each tax return or claim if:

Answer 31

(1) any understatement of tax liability is based on an unrealistic position;
(2) the preparer was aware of or should have been aware of the unrealistic position; and
(3) the unrealistic position was not disclosed as required.

Tax preparers are not required to examine or review documents or other evidence to independently verify a taxpayer’s information. However, preparers are required to make reasonable inquiries if the taxpayer’s information appears to be incorrect or incomplete.