Lesson 3 of Income Tax Planning: Administrative

Question 1

Sources of Tax Law!

Answer 1

Statutory Sources

Administrative Sources

Judicial Sources

Question 2

Statutory Sources

Answer 2

The Internal Revenue Code was initially created by the Revenue Act of 1913.

-In 1939, the entire federal tax law was codified and renamed the Internal Revenue Code of 1939.

-In 1954, a new codification of the “code” was issued.

-The Tax Reform Act of 1986 resulted in the present code, which is the Internal Revenue Code of 1986.

The Internal Revenue Code (IRC) is the first primary source of tax law

Question 3

Administrative Sources

Answer 3

Are They Primary or Secondary Source?

Regulations

Revenue Rulings

Revenue Procedures

Private Letter Rulings

Determination Letters

Technical Advice Memorandum

Question 4

Are They Primary or Secondary Source?

Answer 4

Administrative Law Sources are the second primary source of tax law.

Question 5

Regulations

Answer 5

Regulations are issued by the US Treasury Department and are interpretations of the Internal Revenue Code.

Regulations have the full force and effect of law and are the second highest authority of tax law (after the IRC).

There are three types of regulations:
-Proposed,
-Temporary, and
-Final

Question 6

3 Types of Regulations Meaning

Answer 6

Proposed regulations are a preview of final regulations and do not have legal precedence.

Temporary regulations are issued when guidance is needed quickly and have the same authoritative value as final regulations.

Final regulations have the full force and effect of law. There are three types of final regulations:
-Procedural regulations are essentially housekeeping instructions.
-Interpretive regulations implement the intent of committee reports and the IRC.
-Legislative regulations allow the Treasury to determine the details of the law; however, Congress must specifically delegate this authority to the Treasury.

Question 7

Revenue Rulings

Answer 7

Revenue Rulings are interpretations of the tax laws issued by the Internal Revenue Service (IRS). They are usually provided in response to a taxpayer request and are based on facts common to many taxpayers.

While Revenue Rulings do not have the full force and effect of law, they are binding on officials of the IRS.

Taxpayers can either rely upon the rulings or challenge the rulings in court.

Note that Revenue Rulings may be cited as precedent; courts are not bound by them.

Revenue Rulings are published weekly in the Internal Revenue Bulletin.

Question 8

Revenue Procedures

Answer 8

Revenue Procedures describe internal practices and procedures within the IRS.

Revenue Procedures, like Revenue Rulings, are published in the Internal Revenue Bulletin.

Revenue Procedures generally state changes in techniques and administrative procedures used by the IRS.

Question 9

Private Letter Rulings

Answer 9

Private Letter Rulings (PLRs) are issued by the IRS at the request of the taxpayer.

With regard to the taxpayer who requested the PLR, the IRS is bound by its determination in the ruling.

PLRs are made available to the public after deletion of certain materials and can be used by other taxpayers as guidance regarding the described transaction.

PRs cannot be relied on by other taxpayers as precedent.

Question 10

Determination Letters

Answer 10

Determination letters are issued by District Directors for returns that will be filed in their respective districts.

Determination letters are only issued with regard to completed transactions.

Determination letters are issued only if the answer is specifically covered by:
-Statute,
-Treasury decision or regulation, or
-Ruling opinion or court decision published in the Internal Revenue Bulletin.

Question 11

Example

Answer 11

Howard is considering selling a parcel of real estate and because of various circumstances,
Howard is concerned about the tax ramifications of this transaction. Howard may request a PLR
from the IRS prior to completing the transaction. If, however, Howard completes the transaction
without requesting a PLR, he can still request a determination letter from the District Director of
the district where his tax return will be filed.

Question 12

Technical Advice Memorandum

Answer 12

Technical Advice Memorandums (TAMs) are issued by the national IRS office.

TAMs are usually issued in response to a request by an agent performing an audit.

TAMs provide clarification that cannot be provided by the local IRS office.

Because TAMs are issued in regard to audits, they deal with completed transactions.

TAMs only apply to the taxpayers involved in the audit.

Question 13

Judicial Sources

Answer 13

Judicial decisions are the third primary source of tax law.

When taxpayers cannot resolve disputes with the IRS, they may seek adjudication from the federal courts.

Court decisions are official interpretations and applications of the IRC by the judicial branch of the government.
-In this process, additional tax law is generated that can carry the full force for the statute itself.

Question 14

Administration of the Tax System!

Answer 14

Role of the IRS

Statue of Limitations

Interest & Penalties for Noncompliance

Audits

The Federal Judicial System

Question 15

Role of the IRS

Answer 15

The IRS is organized to carry out the responsibilities of the Secretary of the Treasury under Section 7801 of the Internal Revenue
Code. The secretary has full authority to administer and enforce the internal revenue laws and has the power to create an agency to enforce these laws. The IRS was created based on this legislative grant.

Section 7803 of the Internal Revenue Code provides for the appointment of a Commissioner of Internal Revenue to administer and supervise the execution and application of the internal revenue laws.

Question 16

Statue of Limitations

Answer 16

When a Return Has Not Been Filed

When a Return Has Been Filed

False Tax Return

Question 17

When a Return Has Not Been Filed

Answer 17

When a return has not been filed, the law provides most taxpayers with a three-year window of opportunity for claiming a refund. If no return is filed to claim the refund within the three
years, the money becomes the property
of the US Treasury.

-After the expiration of the refund statute, not
only does the law prevent the issuance of a refund check, it also prevents the application of any credits, including overpayment of estimated or withholding taxes, to other tax years that are underpaid.

-On the other hand, the statute of limitations for the IRS to assess and collect any outstanding balances does not start until a return has been filed. In other words, there is no statute of limitations for assessing and collecting the tax if no return has been filed.

Question 18

In Situation Where a Return Has Been Filed

Answer 18

In situations where a return has been filed, there is a 3-year statute of limitations for the IRS auditing a tax return and a 10-year statute of limitations for the IRS collecting tax.

If the taxpayer omits additional gross income in excess of 25% of the amount of gross income stated in the tax return filed with the IRS, the statute of limitations is 6 years

Question 19

False Tax Return

Answer 19

The statute of limitations does not apply in the case of a false tax return or fraudulent tax return filed with the IRS with intent to evade any tax.

Question 20

Interest & Penalties for Noncompliance

Answer 20

Interest

Penalties

Question 21

Interest

Answer 21

Interest accrues from the original due date of the return, even if the taxpayer obtained an extension.

Interest is compounded daily. The interest
rate is the tederal short-term rate plus 3
percent. That rate is determined ever three months.

Interest is paid on refunds if not received within 45 days of the taxpayer filing a claim for a refund

Question 22

Penalties

Answer 22

The Failure to File

The Failure to Pay
- Underpayment of Estimated Tax
- Accuracy - related penatly.

Question 23

The Failure to File

Answer 23

The failure to file penalty accrues on a monthly basis at the rate of 5% per month up to 25%.

• If the failure to file penalty relates to a fraudulent failure to file, then the penalty is increased to 15% per month up to 75%.
• If a tax return is filed more than 60 days late, the minimum failure to file penalty is $485 for the
  2023 tax year, or the amount of the tax due.

Question 24

The Failure to Pay

Answer 24

The failure to pay penalty accrues at a rate of .5% per month up to 25%.

If both a failure to file penalty and a failure to pay penalty apply, then the failure to file penalty is
reduced by the failure to pay penalty.

-This does not alleviate the need to pay the amount for failure to pay. You pay the reduced
amount for failure to file plus the penalty for failure to pay.

Question 25

Example

Answer 25

Taxpayer did not file on time and owes tax. Consequently, he will owe a failure to file penalty
unless he can show reasonable cause for not filing on time. The combined penalty is 5 percent
(5% failure to file penalty and 0.5% failure to pay penalty, but the failure to pay penalty reduces
the failure-to-file penalty) for each month, or part of a month, that Taxpayer’s return was late, up
to 25%. The failure to file penalty applies to the net tax due. After five months, if Taxpayer still
has not paid, he will have a total penalty of 25% of the net tax due [(4.5 x 5) + (.5 x 5)]. Also, if Taxpayer’s return was over 60 days late, the minimum failure to file penalty is the smaller of
$485 or 100% of the tax required to be shown on the return.

Question 26

Exam Tip

Failure to File = what %
Failure to Pay = what %

Answer 26

File = 5%
Pay = 0.5%

Question 27

Underpayment of Estimated Tax

VERY IMPORTANT

Answer 27

Most people can avoid paying estimated tax if their withholding and credits equal 100% of the tax shown on the prior year’s return or 90% of the current year’s tax liability.

• For taxpayers with AGI above $150,000 ($75,000 MFS) they will pay estimated taxes based
  on 110% of prior year or 90% of current year by January 15th of the following year even
  though the full tax liability is due April 15th.

Taxpayers may not rely on this rule, however, if the taxpayer had a short (less than 12 months)
taxable vear for the previous year.

-In addition, a taxpayer does not have to pay estimated tax if the taxpayer had no tax liability for the previous year; the taxpayer was a US citizen or resident for the entire year; and the
taxpayer’s tax year covered a 12-month period.

The penalty for underpayment of estimated tax is figured the same as interest.

First, determine the amount of the underpayment for each period of time and the number of days in that period, then apply an appropriate interest factor. The interest rate is adjusted from time to time based on market interest rates.

The due dates for estimated tax payments are April 15, June 15, September 15, and January 15.

The penalty is not deductible, even if it arises because of investment or business income.

Question 28

Example

Answer 28

Norton made estimated tax payments of $4,000 per quarter, thinking that $16,000 would be
enough to cover 90% of his tax liability in a year when the prior year safe harbor wasn’t available. It turned out that $18,000 was required to cover 90% of Norton’s tax liability, so Norton
should have paid an additional $500 per quarter.

The amount of Norton’s underpayment is $500
for the period from April 15 to June 15; $1,000 from June 15 to September 15, $1,500 until Jan-
uary 15; and $2,000 until April 15 when Norton filed his return with his payment.

Question 29

Exam Tip

Answer 29

You are very unlikely to have to calculate the exact underpayment penalty due to the complexity of the calculation, but you may need to know when a taxpayer would be subject to the penalty.

Question 30

Accuracy - Related Penalty

VERY IMPORTANT

Answer 30

An accuracy-related penalty of 20% applies to any underpayment due to negligence or disregard of
rules or regulations, or substantial understatement of income tax.

The total accuracy-related penalty cannot exceed 20% of the underpayment. The penalty is not
imposed if there is reasonable cause accompanied by good faith.

Negligence includes the lack of any reasonable attempt to comply with provisions of the Intermal
Revenue Code.

Disregard includes the careless, reckless, or intentional disregard of rules or regulations.

For an individual, income tax is substantially understated if the understatement of tax exceeds the greater of 10% of the correct tax, or $5,000.

Fraud penalty is 75% of the tax underpayment attributed to fraud.

Question 31

Exam Question

John filed his tax return on April 15. At that time, he owed $900 on a total tax liability of
$10,000, and he submitted a check for $900 with his tax return. Which of the following penalties
will apply to John?

a) Failure to file.
b) Failure to pay.
C) Underpayment of estimated tax.
d) None of the above.

Answer 31

Answer: D

Answer A is incorrect because John filed his return on time. Answer B is not correct because
John paid his lax liability when he filed his return. Answer C is not correct because John’s
underpayment was only 9% of his total tax due, so he paid over 90% of his tax liability. Therefore, John is not subject to an underpayment penalty.

Question 32

Audits

Answer 32

A Tax Return May Be Examined for a Variety of Reasons:

The IRS must give taxpayer reasonable notice before

Statue of Limiations

The Following May Represent a Client During an Audit by the IRS

Question 33

A Tax Return May Be Examined for a Variety of Reasons:

Answer 33

A tax return may be examined for a variety of reasons ways, and the examination may take place in any one of several ways.

After the examination, if any changes to the tax are proposed, the taxpayer can either agree with those changes and pay any additional tax he may owe, or the taxpayer can disagree with the changes and appeal the decision.

A return may be selected for examination on the basis of computer scoring. A computer program called the Discriminant Inventory Function (DIF) system assigns a numeric score to each individual and some corporate tax returns atter they have been processed.

• If a return is selected because of a high score under the DIF system, the potential is high that an examination of that return will result in a change to your income tax liability.

A return may also be selected for examination on the basis of information received from third-party
documentation such as Forms 1099 and W-2, that does not match the information reported on the taxpayers return.

A return mav also be selected to address both the questionable treatment of an item and to study the behavior of similar taxpayers (a market segment) in handling a tax issue.

Question 34

The IRS must give taxpayer reasonable notice before

Answer 34

The IRS must give taxpayer reasonable notice before contacting other persons about the taxpayer’s tax matters.

Note: This provision does not apply to any pending criminal investigation, when providing notice would jeopardize collection of any tax liability, where providing notice may result in reprisal against any person, or when the taxpayer has authorized the contact

Question 35

Statue of Limitations

Answer 35

For Assessment of deficiency (owe more money then originall said):
- Generally, 3 years from due date of return
- 6 years if material omission (25% of income)
- No statute if a fraudulent return was submitted.
- No statute if the return was not submitted.

For refund
-Later of: 3 years from date return is filed or 2 years from date of payment.

Question 36

The Following May Represent a Client during an Audit by the IRS

Answer 36

Attorney

CPA

Enrolled agent (EA)
- A person who has either passing a three-part comprehensive IRS test covering individual and
business tax returns, or is an experience former IRS employee. Enrolled agent status is the highest
credential the IRS awards. They can represent taxpayers before the Internal Revenue Service.

Note: A CP® professional may not represent a client during an IRS audit.

Question 37

The Federal Justice System

Answer 37

The US Tax Court

The US Court of Federal Claims

The US District Court

The US Court of Appeals

The US Supreme Court

Chart ( Of Highest to Lowest Courts )

Question 38

The US Tax Court

Answer 38

No payment of tax is necessary in order to bring a claim before the US Tax Court.

Trial by jury is not available.

The Small Tax Case Division handles deficiencies under $50,000 at the taxpayer’s request.
- Note: This is an informal procedure with no appeal rights.

Tax Court decisions do not bind the IRS with respect to other taxpayers.

Appeals are to the US Court of Appeals.

Question 39

The US Court of Federal Claims

Answer 39

Sits only in Washington, DC.

Only hears claims against the United States.

Tax deficiencies must be paid to proceed in this forum.

Appeals are to the US Court of Appeals for the Federal Circuit.

Question 40

The US District Court

Answer 40

Tax deficiencies must be paid to proceed in this forum.

The US District Court is the only forum which allows a jury trial.

The District Court is bound by decisions of its Appeals Court and the US Supreme Court.

Question 41

The US Court of Appeals

Answer 41

There are 12 Circuit Courts, located throughout the United States.

The US Court of Appeals handles appeals from Tax Court and District Court.

The Court of Appeals of one region is not bound to follow the decisions of the court of appeals in
another region.

Question 42

The US Supreme Court

Answer 42

Decisions of the US Supreme Court are binding on taxpayers and the IRS. (Have to Accept Decision)

The US Supreme Court 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, or if
- the decision of a lower court conflicts with long-standing practice or the regulations.

Question 43

Chart ( Of Highest to Lowest Courts )

Answer 43

Question 44

Small Claims Division

Answer 44

Claims less than half $50,000.