R4 Federal Tax Procedures & Legislative Process

Question 1

List the 8 common penalties imposed on taxpayers

Answer 1

1. Earned income credit penalty
2. Penalty for failure to make estimated income tax payments
3. Failure to file penalty
4. Failure to pay penalty
5. Negligence Penalty with respect to Understatement of Tax
6. Penalty for Substantial Underpayment of Tax
7. Penalty for a Substantial Valuation Misstatement
8. Fraud Penalties

Question 2

Summarize the earned income credit penalty

Answer 2

Taxpayers who negligently claim the earned income credit may lose the ability to claim this credit for 2 years, or if fraudulently claimed for up to 3 years

Question 3

Summarize the penalty for failure to make estimated income tax payments

Answer 3

Taxpayers (including corporations, estates and trusts) who do not have sufficient amount of withholding and who do not make timely payments of estimated income tax (including self-employment tax) must pay this penalty, which accrues from the date the estimated income tax must be paid until the tax return due without extensions

Question 4

Summarize the failure to file penalty

Answer 4

Generally, 5% if the amount of tax due for each month (or any portion thereof) the return not filed, penalty cannot exceed a max of 25% of the amount of tax due.

The minimum penalty if the return is more than 60 days late is the lesser of $135 or 100% of the tax due.

If not tax due, then there is no failure to file penalty

If both failure to file and failure to pay penalties are due, the failure to file penalty is reduced by the amount of the failure to pay penalty.

Question 5

Summarize the failure to pay penalty

Answer 5

1/2 of 1% per month (.5%) (of any fraction thereof) up to a max of 25% of unpaid tax.

Exception: No failure to pay penalty if:

1. At least 90% of the tax is paid in by the unextended due date and
2. the balance of the tax is paid by the extended due date (interest is still due on the amount of tax not paid by the unextended due date just that penalty is not charged)

Question 6

Summarize the negligence penalty with respect to an understatement of tax

Answer 6

The penalty amount is 20% if the understatement of tax

Defense: the taxpayer has a reasonable basis for the tax position even if the tax return does not disclose the tax position

Question 7

Summarize the penalty for substantial underpayment of tax

Answer 7

Except as set forth below, and understatement is substantial if the understatement exceeds the greater of 10% of the correct tax or $50,000.

For C Corporations other than PHC, an understatement is substantial if the amount of the understatement exceeds the lesser of: $10 million or the greater of $10,000 or 10% if the correct tax

If the tax return adequately discloses the tax position (other than a tax shelter) then the taxpayer can avoid the penalty if the taxpayer has a reasonable basis for the tax position.

If the tax return does not disclose the tax position, then the taxpayer can avoid the penalty only if the taxpayer has substantial authority for the tax position (except tax shelters)

Question 8

Summarize the penalty for a substantial valuation misstatement

Answer 8

20% penalty on the understatement of tax if there is a substantial valuation.

A substantial valuation misstatement exists if the taxpayer claimed a value (or adjusted basis) that was at least 150% of the property’s correct value (or adjusted basis)

No penalty if the amount of the tax underpayment attributable to the overstatement is not more than $5,000 ($10,000 for corporations other than PHC)

Question 9

Summarize the fraud penalties

Answer 9

Both civil penalties (at least 75% of the understatement of tax due to fraud) and criminal penalties (as high as $100,000 or $500,000 for corporations) can apply.

With respect to a civil penalty, the IRS must prove by a preponderance of the evidence that the taxpayer willfully and deliberately attempted to evade tax.

With respect to a criminal penalty, the IRS must prove beyond a reasonable doubt that the taxpayer criminally, willfully, and deliberately attempted to evade tax.

Question 10

List the Standards of Compliance defenses that are available to avoid or reduce the penalties

Answer 10

1. A position that is not Frivolous (not a defense to penalty)
2. Reasonable Basis Standard
3. Substantial Authority Standard
4. More likely than not Standard

Question 11

Summarize a position that is not frivolous

Answer 11

A position that is NOT frivolous:

1. Not patently or improper but arguable
2. Not a sufficient basis to avoid penalties - even if the tax return discloses the tax position

Question 12

Summarize the reasonable basis standard

Answer 12

A position that has at least 20%+ change of succeeding, one that is arguable but fairly unlikely to prevail in court.

This standard is not met if the taxpayer fails to make a reasonable attempt to determine the correctness of a position that seems too good to be true.

This basis will avoid the negligence penalty with respect to an understatement of tax that is not substantial and the penalty for disregard of rules or regulations, even if the taxpayer does not disclose the tax return position for which the taxpayer has a reasonable basis

This basis will avoid the substantial underpayment penalty only if the taxpayer discloses the tax return position (except for tax shelters) for which the taxpayer has a reasonable basis.

Question 13

Summarize the substantial authority standard

Answer 13

The substantial authority standard is a position that has more than 33% but less than 50% of succeeding

This basis will avoid the substantial underpayment penalty even if the taxpayer does not disclose the tax return position (except for tax shelters) for which the taxpayer has substantial authority

Only analyses and reports issues by the U.S. Congress, IRS Regulations, rules and release and US Court case decision constitute substantial authority. Tax articles and treatises do not constitute substantial authority

Question 14

Summarize the more likely than not standard

Answer 14

The more likely than not standard is a position that has more than a 50% chance of succeeding

For certain non disclosed tax shelters, this basis will avoid the negligence penalty with respect to an understatement of tax that is not substantial and the substantial underpayment penalty

Question 15

What other circumstances will generally allows a taxpayer to avoid a penalty?

Answer 15

A taxpayer generally can avoid any penalty by showing that the taxpayer:

1. Had reasonable cause to support the tax return position
2. Acted in good faith and
3. Did not have willful negligence

Question 16

What is a controlled taxpayer?

Answer 16

Any one of two or more taxpayers owned or controlled directly or indirectly by the same interests, and includes the taxpayer that owns or controls the other taxpayers

Question 17

What is an uncontrolled taxpayer?

Answer 17

Any one of two or more taxpayers NOT owned or controlled directly or indirectly by the same interests

Question 18

What is the definition of controlled?

Answer 18

Controlled includes any kind of control, direct or indirect, including control resulting from the actions of two or more taxpayers acting together.

A presumption of control arises if income or deductions have been arbitrarily shifted

Question 19

What is a controlled transaction or controlled transfer?

Answer 19

Any transaction or transfer between two or more members of the same group controlled taxpayers

Question 20

What is an uncontrolled transaction?

Answer 20

Any transaction or transfer between two or more taxpayers that are NOT members of the same group of uncontrolled taxpayers

Question 21

What is an uncontrolled comparable?

Answer 21

Uncontrolled comparable means the uncontrolled transaction or uncontrolled taxpayer that is compared under any applicable pricing methodology with a controlled transaction or with a controlled taxpayer

Question 22

What is the purpose for the IRS making transfer pricing adjustments?

Answer 22

To assure that reported prices (as adjusted by the IRS) that one affiliate charged to another affiliate yield results that are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances (at arms length)

Question 23

Under what circumstances will the courts not support the IRS making transfer pricing adjustments?

Answer 23

The courts will reverse the IRS adjustment if the controlled taxpayer shows that the results of its transactions are within arm’s length range established by two or more controlled comparable transactions based on a single pricing method.

Question 24

What is the arm’s length standard?

Answer 24

A controlled transaction or controlled transfer meets the arm’s length standard if the results of the transaction or the transfer are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction or transfer under the same circumstances

Question 25

Describe the circumstances that will allow a taxpayer to avoid penalties with respect to IRS imposed transfer pricing adjustments

Answer 25

By the date the taxpayer files the return, the taxpayer completed a 482 study which establishes that the prices charged to affiliates (controlled taxpayers) were reasonable and complied with U.S. Treasury Regulations, if applicable

Question 26

What is the advance pricing agreement program?

Answer 26

A program to resolve actual or potential transfer pricing disputes prior to examination (audit).

The agreement is a binding contract between the IRS and the taxpayer by which the IRS agrees not to seeks a transfer pricing adjustment for a covered transaction if the taxpayer files its return consistent with the agreed transfer pricing method set forth in the contract

Question 27

What elements usually make up an apportion factor used to apportion income to state?

Answer 27

The percentage of the corporation’s property, payroll, and sales in the state.