R6-M5 Federal Tax Procedures

Question 1

How to select tax returns for audit?

Answer 1

• statistical models: select returns that are the most likely to contain errors and yield significant amounts of additional tax revenue upon audit.
• random selection
• information return discrepancy: w2s and 1099s do NOT match the amounts reported on a return
• PY audit
• deductions that exceed established norms: itemized deductions are in excess of norms established

Question 2

what is timing of the audits?

Answer 2

• most individuals are audited within 2 years from the date of filing of the return
• may be audited at any point prior to the expiration of the statue of limitations

Question 3

what is correspondence audit?

Answer 3

review for mathematical errors:
- information errors (SSN or missing signatures)
- matching issues (income reported on tax return does not match w2 or 1099
- mathematical errors

• in case of errors, the taxpayers is typically sent a revised computation and a brief explanation of any changes made along with a bill for additional amount due or check for a refund. There will be NO need for a formal meeting with an IRS representative

Question 4

what are formal examination (office or field audit)?

Answer 4

• IRS office or by correspondence
• field audit: at taxpayer’s office or home or at the place of business of the taxpayer’s representative

Question 5

what happens after the audit?

Answer 5

• issue resolved: no change report and taxpayers sign form 870
• Unresolved issue: taxpayer receives a copy of the IRS agent’s report and a 30-day letter notifying the right to request an administrative appeal (NOT court appeals)

Question 6

what is administrative appeals process?

Answer 6

• first step is handled by the IRS office of Appeals. if agreement reached, taxpayers sign form 870-AD
• if first step not resolved or taxpayers did not request an administrative appeals (30-day letter), taxpayers receives 90-day letter (notice of deficiency) to pay the deficiency or file a petition with the US Tax Court (without paying upfront and applies only for federal tax cases), or can go to the US District Court or the US Court of Federal Claims (must pay upfront and due IRS for refund)

Question 7

what is federal judicial process? 3 courts

Answer 7

1. US Tax Court:
   - trial court hears only federal tax cases
   - no payment required to petition => advantage
   - trial by 1 judge who is a tax expert. No jury => disadvantage
   - Small Claims Division: small cases not exceed $50K for any one tax year. Not considered precedent in other courts
   - decision: 2 types and NOT appealable
   + regular: involves a new or unusual point of law
   + memorandum: application of existing law
2. US District Courts:
   - general trial court of the US. both civil and criminal cases
   - must first pay disputed tax liability and sue the IRS for refund => disadvantage
   - 1 judge and jury trail is option => potential advantage
3. US Court of Federal Claims:
   - No jury
   - must first pay disputed tax liability and sue the IRS for refund => disadvantage
   - handles large tax claims

• US Supreme Court: panel of 9 justices. No jury. Tax cases are RARE

Question 8

what are penalty for failure to make sufficient estimated income tax payments?

Answer 8

Penalty exceptions if withholding and timely estimated payments are:
- less than or equal to $1000 CY tax
- at least 90% of CY tax
- at least %100 of PY tax (110% of PY tax if PY AGI exceeds $150K)
- equal to estimated CY tax based on the annualized of income method

Question 9

what are types of penalty?

Answer 9

• Failure to file: 5% per month of the amount of tax due. Up to 25%
• Failure to pay: 1/2 of 1% per month of unpaid tax. Up to 25%
• Negligence (not substantial): accuracy based. 20% of the understatement of tax
• Substantial underpayment penalty if exceeds the greater of 10% of correct tax or $5000): accuracy based. 20% of the understatement of tax. Same as negligence but harder to avoid.
• Fraud: both civil (at least 75% of understatement of tax) and criminal (as high as 100k; 500k for corps)

Question 10

what are tax position to avoid or reduce penalties?

Answer 10

1. Frivolous tax return: have no basis in law or other authority. < 20% => defense
2. Reasonable basis standard: 20% or higher chance of succeeding. can avoid most penalties
3. substantial authority standard: > 40% but < 50% succeed in court. most undisclosed
4. More-likely-than-not standard > 50%. tax shelters
5. Disclosures for uncertain tax positions: disclose uncertain tax position and help taxpayer avoid understatement penalties
   - Disclosure statement form 8275
   - regulation disclosure statement form 8275-R
   - reportable transaction disclosure statement form 8886: ID by secretary of US Treasury. tax avoidance or tax evasion
6. general avoidance of penalties: if taxpayers can proof:
   - reasonable cause to support
   - acted in good faith
   - did not have willful neglect
   * do not apply if:
   - tax shelter >50% or
   - substantial undisclosed 40-50%

Question 11

what carries the greatest authoritative value for tax planning of transactions?

Answer 11

Internal Revenue Code

Question 12

when will interest on a tax deficiency begin to accrue?

Answer 12

the original tax was due, without regard to extension of time to file