R6 - Other Entity Taxation, Professional Responsibilities, and Federal Taxation

Question 1

What are the types of trial courts considered in the Federal Court system?

Answer 1

1. Tax courts
2. US District Courts
3. US Court of Federal Claims

Question 2

What are the types of appellate courts?

Answer 2

1. US Court of Appeals
2. Federal Court of Appeals
3. Supreme Court of the US

Question 3

What is the role of the appellate courts?

Answer 3

Appellate courts are limited to a review of the trial record of the lower court to determine if that lower court applied the proper law in arriving at its decision.
- Seldom will an appellate court disturb the trial court’s determination of the facts.

Question 4

When can a taxpayer file a petition with the US Tax Court to have the case heard by the Small Cases Division (small tax cases)?

Answer 4

A taxpayer can have the case heard by the Small Cases Division when the amount of tax in dispute does not exceed $50,000 for any tax year.

• Neither party may appeal the decision
• The decision is not considered precedent in other courts.

Question 5

What is the formula to calculate the failure to pay the penalty?

Answer 5

The greater of:
1. Tax liability or 2. Tax liability
- Tax withheld - Tax withheld
= Tax liability due = Tax liability due
* 5% penalty * 25%
* # of months not paid = Failure to pay
penalty
= Failure to pay penalty

Question 6

What is negligence?

Answer 6

It is any failure to make a reasonable attempt to comply with the rules. It may include:
- Failure to keep adequate books and records
- Substantiate items that gave rise to the understatement

A tax position that lacks a “reasonable basis,” is often the target of the negligence penalty.

Question 7

What is the more-likely-than-not tax position?

Answer 7

You need a greater than 50% chance of winning your position to avoid a preparer penalty, tax shelters, reportable transactions.

Question 8

What is the formula to calculate the late payment penalty?

Answer 8

1. Tax liability or capped at 2. Tax Liability
   - Tax withheld - Tax withheld
   = Tax liability due = Tax liability due
   * .5% (.005) penalty * 25%
   * # of months not paid = Maximum Cap
   = Late payment penalty

Question 9

What is the formula to calculate the fraudulent failure penalty?

Answer 9

1. Tax liability or capped at 2. Tax Liability
   - Tax withheld - Tax withheld
   = Tax liability due = Tax liability due
   * 15% penalty * 75%
   * # of months not paid = Maximum Cap
   = Late payment penalty

Question 10

What are money damages?

Answer 10

When a CPA breaches a contract for professional services, the client and any third party beneficiary of the contract are entitled to compensatory money damages

Question 11

What are the elements to make out a case for negligence?

Answer 11

The plaintiff must show the following:
1. The defendant owed a duty of care to the plaintiff
2. The defendant breaches that duty by failing to act with due care
3. the breach caused plaintiff’s injuries
4. Damages.

Question 12

What are the elements of constructive fraud (gross negligence)?

Answer 12

1. A misrepresentation of material fact
2. Defendant acts recklessly (i.e., makes a statement without knowing if it is true or false)
3. Actual and justifiable reliance by the plaintiff on the misrepresentation
4. An intent (also known as scienter) to induce the plaintiff’s reliance on the misrepresentation
5. Damages

Question 13

What are the elements of fraud (Intentional Misrepresentation)?

Answer 13

1. A misrepresentation of material fact
2. Intent to deceive (Knowing the statement was false)
3. Actual and justifiable reliance by the plaintiff on the misrepresentation
4. An intent to induce the plaintiff’s reliance on the misrepresentation
5. Damages

Question 14

What is a scienter?

Answer 14

An intent

Question 15

What is the Ultramares decision (minority rule)?

Answer 15

Limits CPA liability more narrowly to persons in privity of contract with the CPA (clients) and intended third-party beneficiaries.

Question 16

What is privity?

Answer 16

Only a party to the contract can sue under a contract theory

Question 17

Who can the CPA disclose its working papers without a client’s permision?

Answer 17

1. Lawful subpoena
2. Prospective purchasers, as long as the prospective purchaser does not disclose confidential information.
3. Quality control panel
4. AICPA/State trial Board
5. Court proceedings
6. When GAAP requires disclosure of such information in the financial statements.

Question 18

What amount can a donee deduct for a gift made to each donee?

Answer 18

The donor may exclude the first $16,000 (2022) of gifts made to each donee.

Question 19

Under Circular 230, when can a tax preparer charge a contingent fee in connection with matters related to the IRS?

Answer 19

1. IRS examination of, or challenge to, an original tax return (or an amended return or claim for refund or credit that was filed 120 days of receiving a written notice from the IRS).
2. Claim solely for a refund of interest and/or penalties.
3. A judicial proceeding arising under the Internal Revenue Code.

Question 20

What gifts qualify as unlimited exclusions?

Answer 20

1. Payments made directly to an educational institution
2. Payment made directly to a health care provider (e.g., doctor)
3. Charitable gifts to political parties
4. Marital deductions: The donee spouse may receive any distribution of income or principal from the property for his or her lifetime.

Question 21

What are the requirements of a simple trust?

Answer 21

1. A simple trust only makes distribution out of current income; it cannot make distributions from corpus (principal)
2. A simple trust is required to distribute all of its income currently
3. A simple trust cannot take a deduction for a charitable contribution.
4. A simple trust is entitled to a $300 exemption in arriving at its taxable income.

Question 22

What are the requirements of a complex trust?

Answer 22

1. A complex trust may accumulate current income
2. A complex trust may distribute principal
3. A complex trust may deduct charitable contributions
4. A complex trust is permitted an exemption of $100 in arriving at its taxable income.

Question 23

What is the purpose of a trust?

Answer 23

The purpose of a trust is often to protect assets for future generations if no one in the family can manage money (e.g., someone that does not manage money).

Question 24

Are employers liabile for the employee’s injuries at the job under workers’ compensation rules?

Answer 24

Employers are strictly liable regadless of fault. The only requirement is that the employee’s injury occurred while acting in the scope of employment.

Question 25

What is the preparer penalty when there is an unreasonable position of the tax liability?

Answer 25

The preparer penalty is equal to the greater of $1,000 and 50% of the income derived from preparing the return (preparer’s fee)

Question 26

What does the substantial authority tax position represent?

Answer 26

Substantial authority is a higher level of confidence than a resonable basis. It is assumed to be 33 1/3 - 40% chance of winning a position if challenged by the IRS.

Question 27

What is the preparer penalty when there is a willful or reckless understatement of the tax liability?

Answer 27

The preparer penalty is equal to the greater of $5,000 and 75% of the income derived from preparing the return (preparer’s fee)

Question 28

What is the preparer penalty for aiding and abetting an understatement of tax liability?

Answer 28

The civil penalty for aiding and abaiting is $1,000 for all taxpayers except corporations and $10,000 for corporations.

Question 29

What are the reasons for imposing an aiding and abetting penalty?

Answer 29

1. Aids, assist in, procedures, or advises with respect to, the preparation or presentation of any portion of a return, affidavit, claim or other document.
2. Knows (or has reasons to know) that such portion will be used in connection with any material matter arising under the IRC.
3. Knows that such portion (if so used) would result in an understatement of the liability for tax of another person.

Question 30

What is the preparer penalty if a tax preparer knowngly or recklessly discloses or uses false or fraudulent information?

Answer 30

The preparer should pay a maximum annual penalty not to exceed $10,000 and be guilty of a misdemeanor and fined not more than $1,000 and/or be imprisoned for no more than 1 year.

Question 31

What is the preparer penalty for a tax preparer found guilty of making false or fradulent statements in connection with a return?

Answer 31

The tax preparer can be imprisionned for not more than 3 years and fined not more than $100,000 ($500,000 for a corporation).

Question 32

What is a correspondence audit?

Answer 32

It is conducted by mail and typically arises from information errors, mathematical errors, or matching issues. Most common type of audit.

Question 33

What is a reportable transaction?

Answer 33

Any transaction that the Secretary of the US Treasury Department has determined as having a potential for either tax avoidance or tax evasion.

Question 34

When does the more likely than not position apply when determining if a penalty for understatement applies to the tax preparer?

Answer 34

A penalty for understatement of taxpayer liability is applicble to a CPA unless it is reasonable to believe that the position would more likely than not be upheld on its merits.

For certain tax positions, you need a greater than 50% chance of winning your position to avoid a preparer penalty, tax shelter, reportable transactions.

Question 35

When does a 30 day letter issued to the taxpayer by the IRS?

Answer 35

A 30 day letter is send to the taxpayer by the IRS if a settlement has not been reached with the IRS agent during the audit process or to start the appeals process.

Question 36

What happens if the 30 day letter is ignored by the taxpayer?

Answer 36

The IRS will issue a 90 day letter if the appeal process did not result in settlement or if the taxpayer ignores the 30 day letter. The 90 day letter is known as the “statutory notice of deficiency”

Question 37

What action does the taxpayer should take if it receives the 90 day letter?

Answer 37

The taxpayer has 90 days to either pay the tax or petition the tax court. The tax court requires a taxpayer to have received a notice of deficiency before the tax court will accept your case.

Question 38

When does the tax court accepts a case?

Answer 38

The tax court will only accept cases, where no tax has been paid. After 90 days, too late to petition tax court, no reasonable cause exceptions.

Question 39

What happens if the taxpayer does not go to tax court after receiving the 90 day letter?

Answer 39

The only choice is to pay the deficiency, and then go to district court or court of federal claims in Washington DC

Question 40

What information is used by a tax preparer when condudting tax research?

Answer 40

The following are considered primary authoritative sources when one is conducting tax research:
1. Internal Revenue Code
2. Tax court cases
3. Treasury Regulations

Question 41

When is a position deemed unreasonable?

Answer 41

A position is deemed unreasonable unless:
1. Reasonable basis for a disclosed position exists, or
2. Substantial authority for the position, regardless of disclosure, exists, or
3. It is reasonable to believe that a tax shelter or reportable transaction position would meet the more-likely-than-not standard.

Question 42

When an audit is completed, what form is completed as evidence of agreement with the tax officer?

Answer 42

Form 870 (Waiver of Restrictions on Assessment and Collection of Deficiency in tax) and interest stops accumulating on the deficiency 30 day after the form is filed.

Question 43

How is the gift-splitting treated for each spouse making a gift?

Answer 43

A gift by either spouse may be treated as made one-half by each. This gift splitting creates a $32,000 exclusion per donee.

Question 44

What court can the taxpayer go without having to pay a penalty first?

Answer 44

The tax court hears the cases before the tax is paid. The US Tax small case division also falls under this category.

Question 45

What would the taxpayer do to resolve a dispute if he/she decides not go to tax court?

Answer 45

If the taxpayer does not go to tax court after receiving the 90 day letter, then the only choice is to pay the deficiency, and then go to district court or court of federal claims in Washington DC.

Question 46

When can the state board of accountancy conduct a formal hearing for possible disciplinary actions?

Answer 46

After investigation of the accountant’s professional misconduct

Question 47

Are cases heard by the US District Court before a panel of judges?

Answer 47

No, US district court cases are heard only before a judge. The taxpayer can request a jury trial.

Question 48

What court can a losing party may appeal the decision if not satisfied with the result from the tax court, US District court, and US court of Federal claims?

Answer 48

The losing party may appeal the decision to the US Circuit court of appeals for the federal circuit (US Court of Appeals, Federal Court of Appeals, and the Supreme Court of the US).

Question 49

What decisions of the court may be used as precedent in future cases?

Answer 49

1. Regular tax court
2. US District Court
3. US Court of Federal Claims

Only cases heard in the US Tax Court small cases division cannot be cited as precedent in future tax cases.

Question 50

Who has the burden of proof in a civil tax case in any courts available to hearing tax disputes?

Answer 50

The taxpayer has the burden of proof.

Question 51

Can the taxpayer represent himself/herself and in what courts?

Answer 51

The taxpayer can represent himself/herself in the US Tax court of small cases division, regular US tax court, US district court, US court of federal claims.

Question 52

Does a taxpayer have to physically go to Washington DC to have a case tried?

Answer 52

No, US districts courts have a fixed physical location within the particular district. The US tax court is based in Washington DC, but has courtrooms thoughout the country.

Question 53

What is a tax-exempt organization?

Answer 53

Although an organization might have tax-exempt status, it may be subject to regular income tax on income from a business enterprise that is not related to its tax-exempt purpose (UBI)

Question 54

What is unrelated business income (UBI)?

Answer 54

A tax-exempt organization may be subject to regular income tax on income unrelated to its tax-exempt purpose (UBI). The income might be derived from:
1. An activity that constitutes a trade or business
2. Regularly carried on, and
3. No substantially related to the organization’s tax-exempt purpose.

Question 55

What is considered excluded trade or business from a tax-exempt organization?

Answer 55

1. Bingo games (if legal and limited to not-for-profit organizations in the jurisdiction where the game is played)
2. Activity conducted for the convenience of an organization’s members, students, patients, or employees.
3. Convention or trade show activity
4. Exchange or rental membership lists
5. Sale of merchandise received as gifts or contributions (e.g., thrift shop)
6. Sale of articles made by a disabled person as part of their rehabilitation
7. Activity where substantially all the work is performed by unpaid volunteer workers

Question 56

What income is excluded from a tax-exempt organization?

Answer 56

Excluded type of income:
1. Dividends, interest, annuities, and other investment income
2. Royalties.
3. Rents from real property (unless personal services also provided, or the lease includes both real property and personal property, and the rents attributable to the personal property are more than 50% of the total rents).
4. Income from research by a college, university, or hospital.
5. Gains and losses from disposition of property not held primarily for sale to customers in the ordinary course of business.

Question 57

Is the CPA required to reveal confidential client information in an official investigation of the AICPA/state trial board?

Answer 57

Yes, the CPA will be required to provide confidential client information if the AICPA/state trial board is performing an ethics/official investigation

Question 58

Can a decision made by the Small Cases Division of the US tax court be appealed?

Answer 58

No, a decision made by the Small case division of the US Tax court is not appealable.

A decision can be appealed to the regular division of the US tax court.

Question 59

If an agreement is not reached between the taxpayer and the revenue agent during the audit process, what are the steps to settle the dispute?

Answer 59

1. Taxpayer receives the revenue agent’s report (taxpayer did not agree with the revenue agent’s recommendation and did not sign the agent’s report)
2. The 30 day letter comes with the report. The taxpayer has 30 days to reach a settlement with the IRS or start the appeal process.
3. If taxpayer uses the appeal’s process, and it’s granted, the taxpayer files the “protest letter” for each disputed item. The primary authority behind the position contrary to the IRS agent’s examination must be stated (e.g., ligislative authority, judicial authority, administrative auhtority, or primary authority).
4. if an agreement is reached on appeal, the taxpayer pays the agreed amount and case is settled.
5. if appeal process fails or taxpayer ignores the 30 day letter, the IRS issues the 90 day letter or “statutory notice of deficiency.” the taxpayer has 90 days to pay the tax or petition the tax court.
   - For the tax court to hear the case, the 90 day letter had to be issued first and no tax should have been paid.
6. The taxpayer filing the petition with tax court has the option of having the case heard before the Small cases division (small tax cases) if the amount of tax in dispute does not exceed $50,000 for any tax year.
   - Neither party may appeal the decision and the decision is not considered presedent.
7. if taxpayer does not go to tax court after the 90 day letter, then taxpayer pays the deficiency, and goes to district court of federal claims.

Question 60

How can a taxpayer generally avoid any penalty?

Answer 60

The taxpayer can show the following:
1. Had reasonable cause to support the tax return position
2. Acted in good faith, and
3. Did not have willful neglect.

Question 61

What are the two forms of accuracy-related penalties and what’s the penalty applied to both of them?

Answer 61

The accuracy-related penalties is comprised of the negligence penalty or the substantial understatement penalty. Both penalties are the same 20%, and the IRS does not charge for both. It’s either one or the other.

The main difference between the two is that the substantial authority penalty is more difficult to avoid. Negligence penalty can be avoided easily.

Question 62

How to determine if the penalty is substantial or not?

Answer 62

The substantial understatement peanlty is computed as follows:
the understatement amount > of the greater of:
1. 10% of tax liability
2. $5,000 (used for individual taxpayer) or $10,000 (used for corporations)
The substantial understatement penalty is calculated as follows:
Substantial understatement penalty = Understatement amount * 20%

if the understatement amount is less than the two amounts above, then it is not substantial

Question 63

How is the negligence penalty computed?

Answer 63

Negligence penalty = 20% * understatement amount

Question 64

How does the failure to be diligent in determining a Client’s elegibility for the Earned Income credit works?

Answer 64

The failure to comply with the requirements to determine the elegibility for, or the amount of, the earned income credit is $560 for each failure. The due diligence requirements must be applied.

Question 65

What are the due diligence requirements to to comply with the determination of the earned income credit elegibility?

Answer 65

1. Elegibility checklist
2. computation worksheet
3. reasonable inquiries to the taxpayer
4. record retention