Tax Ch 2

Answer 1

SOURCES OF TAX LAW (1 OF 2)

Priority
Low
High

The 16th Amendment to the U.S. Constitution

Admin Action
Judicial Decisions
Statutory Law

Answer 2

SOURCES OF TAX LAW (2 OF 2)

Answer 3

TAX AUTHORITY
* Initially created by the Revenue Act of 1913
* In 1939, the entire federal tax law was codified and entitled
the Internal Revenue Code of 1939.
* In 1954, a new codification of the “Code” was issued.
* The present Code is the Internal Revenue Code of 1986, as
amended

Answer 4

ORGANIZATION OF THE INTERNAL REVENUE CODE
Subtitle
Chapters & Subchapters
Parts & Subparts
Sections & Subsections
Paragraphs &
Subparagraphs

Answer 5

THE LEGAL IMPACT OF THE IRC

• Source of statutory law on taxation
• Must be adhered to unless a provision is declared unconstitutional
• Only Congress can amend the Code
• Ambiguous provisions of the Code are interpreted by the Court

Answer 6

HOW A BILL BECOMES TAX LAW:
THE LEGISLATIVE PROCESS

Answer 7

THE TREASURY’S FUNCTIONS

• Enact Regulations
• Official Treasury interpretation of the Code
• To the extent the regulations are consistent with the Code, they
  have the force and effect of law.
• Issue Revenue Rulings and Private Rulings
• Issue Revenue Procedures
• Issue Determination Letters
• Manage Conflict with Taxpayer

Answer 8

REGULATIONS: STAGE OF ADOPTION

• Proposed
  – Preview of final regulations
  –Do not have legal precedence
• Temporary
  – Issued when guidance is needed quickly
  –Same authoritative value as final regulations
• Final
  -Have force and effect of law
  –Binding on Taxpayers and Treasury

Answer 9

FINAL REGULATIONS

• Procedural
  –Housekeeping instructions
• Interpretive
  – Implement intent of committee reports and Code
• Legislative
  – Allows Treasury to determine the details of the law
  – Congress must specifically delegate authority

Answer 10

REVENUE RULING

• Based on facts common to many taxpayers
• Binding on the IRS
• Taxpayers can:
  –Rely upon the rulings
  –Challenge the rulings in court
• Courts are not bound by Revenue Rulings
• Published weekly in the Internal Revenue Bulletin

Answer 11

PRIVATE LETTER RULING (PLR)

• Issued at the request of the taxpayer
• The IRS is bound by its determination in the ruling
• Made available to the public
• Cannot be relied on by other taxpayers as precedent (but may
  provide insight into IRS positions)

Answer 12

DETERMINATION LETTERS

• Issued by District Directors for returns filed in their respective
  districts
• Must be a completed transaction
• Issued only if answer is covered specifically by:
  – Statute
  –Treasury decision or regulation
  –Ruling opinion or court decision published in the Internal
  Revenue Bulletin

Answer 13

REVENUE PROCEDURES

• Describe internal practices and procedures within the IRS
• Published in the Internal Revenue Bulletin
• Generally state changes in techniques and administrative
  procedures used by the IRS

Answer 14

JUDICIAL SOURCES OF TAX LAW

• Courts
  –nterpret statutory ambiguity
  – Cannot issue advisory opinions
  –Need “Case or Controversy”
• Court opinions are binding on lower courts, the IRS, and taxpayers

Answer 15

ADMINISTRATION OF THE TAX SYSTEM

• Managed by the Internal Revenue Service (IRS)
• Important Issues:
  –Statute of Limitations
  – Interest and Penalties
  – Audits
  –Dispute Resolution

Answer 16

STATUTE OF LIMITATIONS

Answer 17

INTEREST AND PENALTIES

• Interest
  – Accrues from due date of return
  –Paid on refunds if not received within 45 days of filing
• Penalties
• Failure to file
• Failure to pay
• Accuracy related penalty
• Fraud penalties
• Underpayment of estimated tax
• Negligence

Answer 18

FAILURE TO PAY AND FAILURE TO FILE PENALTIES

• Failure to File
• 5% per month or part thereof
  – If fraud, 15%/month
• Maximum of 25% (5 months)
  – If fraud, 75%
• If 60 days late, minimum $485 (2023) ($450 in 2022) or 100% of
  tax due
• Reduced by failure to pay penalty
• Failure to Pay
  –0.5% per month or part thereof
  –Maximum of 25% (50 months)

Answer 19

TAXPAYER NONCOMPLIANCE PENALTIES: EXAMPLE (1 OF 2)
Several years ago, Deacon failed to file a tax return or pay his taxes.
He owed $5,000 in taxes. Deacon’s tax return and his tax payment are both now 22 months overdue.

Deacon is subject to a failure to file penalty of $1,250 (maximum 25% penalty x $5,000). He is also subject to a failure to pay penalty of $550 (0.5% x 22 months x $5,000).

Fortunately for Deacon, because he is subject to both the failure to file and failure to pay penalties, the first five months of delinquency is
subject to the maximum 25% penalty.

Thereafter, the $5,000 unpaid balance is still subject to the 0.5% failure to pay penalty of $425 (0.5% x 17 months x $5,000), for a total combined penalty of $1,675 ($1,250
+ $425)

Answer 20

TAXPAYER NONCOMPLIANCE PENALTIES:
EXAMPLE (2 OF 2)

Answer 21

FRAUD PENALTIES

• 75% of underpayment of tax
• $5,000 for frivolous or incomplete tax return
• May also lead to criminal prosecution
• Willful failure to file/pay = misdemeanor
  –Penalty up to $25,000 and 1 year in jail
• Willful attempt to evade = felony
  – Penalty up to $100,000 and 5 years in jail
• Willfully makes false return = felony
  – Penalty up to $100,000 and 3 years in jai

Answer 22

PREPARER PENALTIES
* Procedural
–Failure to provide copy of return
– Failure to sign as preparer
-Failure to keep copy
–Failure to maintain client list

• Statutory Penalties
  – Understatement due to unrealistic position
• Willful attempt to understate tax
  – Failure to exercise due diligence - earned income credit, child
  tax credit, and American Opportunity tax credi

Answer 23

MISSION OF THE IRS

Provide America’s taxpayers top
quality service by helping them
understand and meet their tax
responsibilities and
enforce the law with integrity and
fairness to all

Answer 24

AUDITS

• Mismatch of Return and Reporting Documents
• Discriminate Inventory Function (DIF)
  – Computer matching and scoring
• Related party audits
• Targeted compliance audits
• Subsequent claims for refund
• Financial status audits

Answer 25

DISPUTE RESOLUTION PROCESS
* Examination
* 30-day letter
–Taxpayer can appeal to IRS appeals office within 30 days
– IRS appeals office is separate from examination division

• If no internal appeal, 90-day letter issued (Notice of deficiency)
• Taxpayer has 90 days to:
  – Pay, or
  –File a petition in tax court without first paying the tax, or
  –Pay tax and file suit in District Court or the U.S. Court of
  Federal Claims.

Answer 26

THE FEDERAL JUDICIAL SYSTEM

Answer 27

THE U.S. TAX COURT

• No payment of tax is necessary
• Trial by jury not available
• Small Tax Case Division: Deficiencies up to $50,000 at the
  taxpayer’s request
  – Informal procedures; no appeal rights
• Tax Court decisions do not bind the IRS with respect to other
  taxpayers.
• Appeals are to the U.S. Court of Appeals

Answer 28

THE U.S. TAX COURT

• No payment of tax is necessary
• Trial by jury not available
• Small Tax Case Division: Deficiencies up to $50,000 at the
  taxpayer’s request
• Informal procedures; no appeal rights
  –Tax Court decisions do not bind the IRS with respect to other
  taxpayers.
  –Appeals are to the U.S. Court of Appeals

Answer 29

THE U.S. COURT OF FEDERAL CLAIMS

• Sits only in Washington, D.C.
• Tax deficiencies must be paid to proceed in this forum
• Appeal is to the U.S. Court of Appeals for the Federal Circuit

Answer 30

THE U.S. COURT OF APPEALS

• 12 Circuit Courts
• Handles appeals from Tax Court and District Court
• Court of Appeals in one circuit is not bound to follow the decisions
  of the court of appeals in another circuit

Answer 31

THE U.S. SUPREME COURT

• Decisions are binding on taxpayers and the IRS.
• 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.
  – The decision of a lower court conflicts with long-standing practice
  or the regulations

Answer 32

DECISION TREE: FORUM SHOPPING

Answer 33

COURT COMPARISON

Answer 34

TAX RESEARCH

• Primary Sources
  – Internal Revenue Code (IRC)
  – Treasury Regulations (Treas. Reg.)
• IRS Rulings
  – IRS Manual
  – Court Opinions
• Secondary Sources
  – Research Institute of America (RIA)
  –Commerce Clearing House (CCH)
  – Bloomberg BNA (BNA)

Answer 35

PERIODICALS AS A SOURCE OF TAX INFORMATION

• Federal Tax Articles (CCH)
• Journal of Taxation
• Tax Notes
• Monthly Digest of Tax Articles
• Journal of the Society of Financial Services Professionals
• Estate Planning
• Trusts and Estates
• Journal of Financial Planning

Answer 36

KEEPING UP WITH NEW DEVELOPMENTS

• CCH and RIA
• Accounting Firm Websites
• TaxProTalk.com (formerly Tax Almanac)
• The Daily Tax Report, published by the Bureau of National Affairs
• LexisNexis and Westlaw
• IRS.gov

Question 37

The first constitutionally permitted income tax was imposed by:

Answer 37

The Revenue Act of 1913.
Rationale

Although the 16th Amendment gave Congress the authority to impose an income tax, it was the Revenue Act of 1913 that actually imposed an income tax on U.S. citizens.

Question 38

Calvin recently filed his tax return. He failed to file a proper extension and then filed 80 days after the due date. Along with his return he remitted a check for $4,000, which was his full income tax liability without penalties. What is Calvin’s total penalty?

Answer 38

The failure-to-file penalty is: $600.

(5% x 3 months x $4,000) – $60 (failure-to-pay penalty - see below) = $540. Note that the penalty period is three months because 80 days is more than two months, and each part of a month counts as a whole month.

The failure-to-pay penalty is: 0.5% x 3 months x $4,000 = $60.

Total penalty = $600

Question 39

Danica failed to file her tax return a few years ago and paid the $5,000 tax liability that was owed at the time. Danica’s new tax advisor prepares and files the return in the current year, 21 - 1⁄2 months late. How much is her: ???

1. Failure-to-pay penalty.
2. Failure-to-file penalty.
3. Total penalty.

Answer 39

$550; $1,125; $1,675.

Rationale

Failure-to-pay: [0.5% per month, continues to accrue for up to 50 months]
0.005 x 22 months x $5,000 = $550

Failure-to-file: [5% per month up to a max of 25% LESS failure-to-pay penalty for those months in which the failure-to-file penalty applies]

25% x $5,000 = $1,250 LESS (0.005 x 5 months x $5,000) = $1,125

Total = $1,675

Question 40

Individual income taxes make up nearly 50% of the gross collections by the Internal Revenue Service. In which of the following courts is a jury trial available to decide tax controversies?

Answer 40

A U.S. District Court.

Rationale

A jury trial is only available in tax controversies adjudicated by the U.S. District Court. Only bench trials are available in the other venues

Question 41

Patrick is considering a business transaction. After speaking with his accountant he has determined that the Internal Revenue Code is not clear on the tax treatment of his business transaction. Because the tax dollars at stake are substantial, Patrick is not comfortable completing the transaction without first knowing how the transaction will be treated by the IRS. Which of the following would give Patrick the most peace of mind prior to completing this transaction?

Private Letter Ruling.
Determination Letter.
Revenue Ruling.
Technical Advice Memorandum.

Answer 41

Private Letter Ruling.

Rationale

The private letter ruling is a ruling from the IRS on how they will treat a proposed transaction. It is binding on the IRS for the taxpayer that requests it.

The determination letter is for a completed transaction.

A revenue ruling is a ruling of the IRS’s position given a broad set of facts. Revenue rulings do not have the full force and effect of law.

A Technical Advice Memorandum is requested by an IRS agent during an audit.

Question 42

The failure-to-file penalty is reduced by which one of the following?

failure-to-pay penalty.
Estimated tax payments.
20 percent of the underpayment penalty.
The fraud penalty.

Answer 42

The failure-to-pay penalty.

Rationale

The failure-to-file penalty is reduced by the failure-to-pay penalty.

Question 43

Ozzy failed to pay $5,000 of income tax due with the filing of his return, which was timely filed on April 15th. He waits until June 10th after April 15th to pay the tax. How much will his penalties be?
$25.
$50.
$55.
$75

Answer 43

$50.

Rationale

The amount for failure to pay is point five percent (0.5%) per month or part of month up to a maximum of 25 percent = $5,000 x 0.005 x 2 months = $50.

When determining the failure-to-pay penalty a month begins on the due date of the return and runs until the corresponding date in the succeeding calendar month; it is not based on a calendar month.

In addition, any partial months are treated as a full month. Therefore, Ozzy must pay the penalty for a period of 2 months: April 15 - May 15 and May 15 - June 15.

Question 44

Which of the following statements regarding administrative tax law issued by the IRS are correct?

1. Revenue rulings are based on a set of facts that are common to many taxpayers.
2. Private letter rulings are issued at the request of an individual taxpayer.
3. Determination letters are issued prior to the completion of a transaction to reduce tax risk.

Answer 44

1 and 2.
Rationale

Determination letters are issued at the request of a taxpayer by the district director of the IRS when the taxpayer has already engaged in a transaction and would like to know how to report the transaction for tax purposes.

Question 45

The Tax Reform Act of 1986 was roughly revenue neutral because:

1. It was supported by both Republicans and Democrats.
2. It was not intended to raise or lower total tax revenues.
3. It divided the tax burden evenly between individuals and businesses.
4. It made the tax rates equal across all tax brackets

2 only.
1 and 3.
2 and 3.
1, 2, and 4.

Answer 45

2 only.

Rationale

A piece of tax legislation is considered revenue neutral when it is expected to neither raise nor lower the total amount of tax revenues to be collected

Question 46

The maximum accuracy-related penalty is:

20 percent of the underpayment.
25 percent of the underpayment.
30 percent of the underpayment.
75 percent of the underpayment.

Answer 46

30 percent of the underpayment.

Rationale

Although the maximum accuracy-related penalty is generally 20%, that penalty can be raised to 30% for understatement of tax liability due to undisclosed listed transactions (certain transactions listed by the IRS as tax-shelter devices).

Question 47

Carrie’s husband, Drew, died last year. Before his death, Drew exercised a substantial number of incentive stock options (ISOs). Before they could pay the tax, the stock decreased in value, leaving them no cash to pay the alternative minimum tax (AMT) that resulted from the exercise. Carrie would like to challenge the amount due in court, as she has already exhausted the internal IRS review process. Her lawyer believes that the facts of the case may help Carrie if she has a sympathetic audience. However, she is unable to pay the claim currently and her top priority is to choose a court that does not require her to pay up-front. She would like to be able to appeal if the lower court does not render a decision in her favor.
Which court is most appropriate for Carrie?

U.S. District Court.
U.S. Court of Federal Claims.
U.S. Tax Court.
U.S. Tax Court: Small Claims Division

Answer 47

U.S. Tax Court.

Rationale

Since Carrie’s top priority is that she can’t pay the deficiency, the Tax Court and Small Claims Division are the only options. We do not know if she would qualify for the small claims division (claims less than $50,000) but since she wants to be able to appeal this is not an option either. Although a jury trial is not available in the Tax Court, Carrie did state that not paying the deficiency is her top priority

Question 48

Which of the following sources of tax law may not be relied upon by a taxpayer?

1. Proposed Regulations
2. Revenue Rulings
3. Private Letter Rulings
4. Temporary Regulations

1 and 3.
2 and 4.
2 and 3.
1, 2, and 3.

Answer 48

1 and 3.

Rationale

Proposed regulations and Private Letter Rulings

cannot be relied upon for legal precedence.

Both Revenue Rulings and Temporary Regulations may be relied upon.

Question 49

Ashton filed his tax return on April 15. When preparing his return, Ashton accidentally stated that his income was $50,000 when it was really $500,000. What is the statute of limitations prior to which the IRS may examine Ashton’s return?

3 years.
6 years.
10 years.
There are no statute of limitations.

Answer 49

6 years.

Rationale

Because Ashton had a substantial understatement of his gross income on his tax return, the IRS has six years to examine his return. Ashton had a substantial understatement because he omitted 90% of his gross income.
However, because the problem indicates that Ashton’s omission was an accident, it does not appear that he committed fraud. If he had committed fraud, then there would be no statute of limitations.

Question 50

Which of the following sources has the highest tax validity?
A. Revenue Ruling
B. Revenue Procedure
C. Regulations
D. Technical Advice Memoranda
E. None of the above

Answer 50

??

Question 51

Which item may be cited as a precedent?
A. Regulations
B. Temporary Regulations
C. U.S. Tax Court decision
D. All of the above

Answer 51

??

Question 52

A jury trial is available in the following trial court:
A. U.S. Tax Court
B. U.S. Court of Federal Claims
C. U.S. District Court
D. U.S. Circuit Court of Appeals
E. None of the above

Answer 52

C. U.S. District Court

Question 53

Mila filed her tax return on April 15. At that time, she owed $800 on a total income tax liability of $10,000 and she submitted a check for $800 with her income tax return. Which of the following penalties will apply to Mila?

Failure to file.
Failure to pay.
Underpayment of estimated tax.
None of the above

Answer 53

None of the above.
Rationale

Option a is incorrect because Mila filed her return on time.
Option b is not correct because Mila paid her tax liability when she filed her return.
Option c is not correct because Mila’s underpayment was only 8% of her total tax due, so she paid over 90% of her tax liability. Therefore, Mila is not subject to an underpayment penalty.

Question 54

Which of the following statements regarding administrative tax law issued by the IRS are correct?

1. Revenue rulings are based on a set of facts that are common to many taxpayers.
2. Private letter rulings are issued at the request of an individual taxpayer.
3. Determination letters are issued prior to the completion of a transaction to reduce tax risk.

1 only.
1 and 2.
2 and 3.
1, 2 and 3.

Answer 54

1 and 2.
Rationale

Determination letters are issued at the request of a taxpayer by the district director of the IRS when the taxpayer has already engaged in a transaction and would like to know how to report the transaction for tax purposes.

Question 55

Began as proposed or temp regulations and have the full force and effect of law.

Temporary Regulations
Proposed Regulations
Final Regulations
Revenue Rulings

Answer 55

The correct answer is C.

Question 56

Federal tax legislation generally originates in what body?

A. Internal Revenue Service
B. Senate Finance Committee
C. House Ways and Means Committee
D. Senate floor

Answer 56

Solution: The correct answer is C

Question 57

Which of the following sources has the highest tax validity?

Revenue Ruling
Revenue Procedure
Regulations
Technical Advice Memoranda
None of the choices

Answer 57

The correct answer is C. Regulations

Question 58

Which item may be cited as a precedent?

A. Regulations
B. Temporary Regulations
C. US Tax Court decision
D. All of the choices

Answer 58

Solution: The correct answer is D.

Question 59

Which statement is not true with respect to the U.S. Tax Court?

A jury trial is available.
They issue both Regular and Memorandum decisions.
The IRS may acquiesce to its decision.
A taxpayer does not have to pay the deficiency before litigating in this court.

Answer 59

Solution: The correct answer is A.

Question 60

A characteristic of the statute of limitations is:

A. A three-year statute of limitations applies to all tax returns.

B. A different statute of limitations applies to tax refunds and deficiencies.

C. A six-year statute of limitations applies if gross income is understated by more than 20%.

D. There is a six-year statute of limitations on assessments of tax if a fraudulent return is filed.

Answer 60

The correct answer is B.

The three-year statute of limitations applies to timely filed returns reporting substantially proper amounts of income and deductions .

The statute of limitation is not the same for refunds and deficiencies. A six-year statute of limitations applies to returns understating income in excess of 25 percent.

If a fraudulent return is filed for a particular year, the statute of limitations never expires.

Question 61

Dante filed his individual income tax return on August 29th this year and owed $10,000 in taxes on the return. What is the total amount of failure to file and failure to pay penalties Dante owes?

$0
$200
$1,800
$2,000

Answer 61

The correct answer is D.

Based on the fact pattern, the failure-to-file penalty is 5% per month up to a maximum of 25% of unpaid tax. Dante filed 4 months late (April 15 to August 15), so his failure-to-file penalty is 4 months x 5%x $10,000 owed = $2,000.

The failure-to-pay penalty is 0.5% per month up to a maximum of 25%. For the months the failure-to-file penalty applies (April-July. Dante has 4 months x 0.5% x $10,000 owed = $200.

When both penalties concurrent, the failure-to-file amount is reduced the failure to pay amount. Think of it as paying a discount on the failure to file when you also owe failure to pay. The taxpayer does not get out of paying failure to pay.

The total penalties Dante owes are ($2,000 failure to file - $200 failure to pay) + $200 failure to pay = $2,000 total penalty.