Unit 1

Question 1

Primary Sources of Authority

Answer 1

In tax court or before the IRS, only primary sources of authority carry weight.
Congress: Passes tax laws (legislative branch).
Treasury Department (via IRS): Enforces tax laws (executive branch).
Tax Court: Interprets tax law (judicial branch).

Question 2

Congress (source of authority)

Answer 2

Passes tax laws (legislative branch).

Question 3

Treasury Dept (source of authority)

Answer 3

via IRS: Enforces tax laws (executive branch).

Question 4

Secondary Sources

Answer 4

Explain and interpret the Internal Revenue Code (IRC).
Examples:
RIA (Research Institute of America)
CCH (Commerce Clearing House)
BNA (Bureau of National Affairs)

Question 5

Treasury Relations carry what

Answer 5

carry the “full force and effect of the law”

Question 6

Congressional Committee Reports

Answer 6

provide insight into Congress’s intent behind laws

Question 7

Revenue Rulings

Answer 7

issued by the IRS, serve as precedent for taxpayers in similar scenarios

Question 8

Technical Advice Memos (TAMs)

Answer 8

offer precedents for taxpayers

Question 9

Private Letter Rulings

Answer 9

specific to the taxpayer they’re addressed to, lacking assurance of similar treatment for others.

Question 10

Filing Requirements

Answer 10

If you’re a U.S. citizen or resident alien, you need to file taxes if your income surpasses the standard deduction plus personal exemptions, even if you owe no tax. There are exceptions for penalties, self-employment taxes, or if you’re eligible for refundable tax credits.

Question 11

Document Matching Program

Answer 11

Compares IRS records like W-2s, 1099s, 1098s, with filed documents.

Question 12

DIF (Discriminate Functions System program)

Answer 12

Matches return information to set norms.

Question 13

TCMP (Taxpayer Compliance Measurement Program)

Answer 13

Randomly checks 50,000 returns, verifying each line item. Suspended since 1995, but active again since 2006 to establish norms and promote compliance.

Question 14

Targeted programs

Answer 14

Focus on specific professions like wait-staff, hairdressers, real estate agents, and Schedule C income for sole proprietors.

Question 15

Penalties applied only to C corp

Answer 15

Personal Service Corporations (PSC), Accumulated Earnings Tax (AET), and undistributed income from a Personal Holding Company (PHC) apply only to C Corporations.

Question 16

Negligence

Answer 16

If you make a mistake on your taxes without intending to cheat, you’ll owe a 20% penalty on the amount you owe, plus interest.

Question 17

Fraud

Answer 17

If you purposely cheat on your taxes, you’ll face a 75% penalty on the amount you owe. However, if you filed jointly and your spouse didn’t know about the fraud, they won’t be penalized (Innocent Spouse Rule).

Question 18

Understatement of liability applies to

Answer 18

annual returns and quarterly estimates

Question 19

Understatement of Liability

Answer 19

This rule affects both your yearly tax return and the money you pay in taxes every three months (quarterly estimates).
If the amount you’ve paid in taxes throughout the year is less than:
90% of what you owe for the current year, or
100% of what you owed the previous year (or 110% if your previous year’s income was over $150,000, or $75,000 if you’re married filing separately).
You won’t get a penalty for underpaying taxes if:
You owe less than $1,000 in taxes after deductions.
You didn’t owe any taxes the year before on a return that covered the entire year.

Question 20

Frivolous return

Answer 20

An example would be filing a return with “Go Pound Sand” written on the return. Penalty is $500.

Question 21

Failure to file

Answer 21

If you don’t pay your taxes on time and it’s not because you ignored them on purpose or for a good reason, you’ll owe a penalty.
The penalty starts at 5% of what you owe for the first month, and then increases by 5% each month, up to a maximum of 25%.
If you don’t file your tax return within 60 days after the due date, you’ll face a minimum penalty of $100.

Question 22

Preparer Penalties

Answer 22

Penalties apply for different actions:
-Not signing the return or providing Social Security Number (SS#) or Taxpayer Identification Number (Tax ID#).
-Failing to give the taxpayer a copy of the return.
-Not keeping copies of all returns for at least three years.
-Using or sharing client information from the tax return without permission.

Question 23

Accumulated Earnings Tax

Answer 23

-The Accumulated Earnings Tax is a penalty imposed on corporations that save more money than necessary for business operations.
-Personal Service Corporations (PSCs) can only save up to $150,000, while other corporations can save up to $250,000.
-Beyond these limits, a penalty tax of 20% is applied to the excess amount.
-This penalty is added to the regular tax due.
-Businesses can avoid this penalty by proving they have a legitimate need for the saved cash.

Question 24

How to find accumulated earnings tax

Answer 24

Start with the corporation’s taxable income.
Subtract income taxes payable and dividends paid to shareholders.
This gives you the accumulated earnings for the current year.
Add the beginning balance of accumulated earnings from the prior year.
Subtract the appropriate threshold ($150,000 or $250,000).
This gives you the accumulated earnings subject to penalty.
Multiply this amount by 20% to find the accumulated earnings tax penalty.

Question 25

Undistributed income of a Personal Holding Company

Answer 25

To qualify as a Personal Holding Company (PHC), it must pass two tests:
Stock Test: More than 50% of the company’s stock must be owned by five or fewer individuals.
Income Test: At least 60% of the company’s Adjusted Gross Income (AGI) must come from PHC income sources. These include interest, dividends, royalties, rental income, annuities, oil & gas royalties, personal service income, copyright royalties, taxable income from estates and trusts, and payments received by a shareholder who owns 25% or more of the company’s stock for using corporate property.

Question 26

Undistributed income of a PHC tax penalty calculation

Answer 26

-Start with the corporation’s taxable income.
-Add back the Dividends Received Deduction.
-Subtract the income taxes payable and dividends paid to shareholders.
This gives you the PHC’s undistributed income.
Multiply this undistributed income by 20% to calculate the PHC undistributed income tax penalty.

Question 27

Sham transaction doctrine

Answer 27

-The IRS disregards transactions deemed as “sham.”
-This means no gains or losses are recognized for tax purposes.
-For instance, if one entity sells property to another controlled by the same person(s), the IRS might see it as an attempt to manipulate taxes, disallowing the transaction for tax purposes.

Question 28

Step Transaction Doctrine

Answer 28

-The courts developed this set of rules.
-It allows them to ignore individual transactions and focus on the overall economic impact.
-Even if each transaction is legal on its own, they analyze the combined effect to determine the true economic reality.

Question 29

Substance over Form Doctrine

Answer 29

-The tax outcome of a transaction depends on its substance, not just its form.
-For instance, if two parties exchange properties at a loss, the IRS might consider it a like-kind exchange based on the substance of the transaction, despite the apparent loss on paper.

Question 30

Assignment of Income Doctrine

Answer 30

-For tax purposes, “Tree” (asset) and “Fruit” (income) cannot be separated.
-If a parent earns income, they can’t give it to their child to avoid taxes.
-However, if the parent transfers the asset generating the income to the child, then the income will be taxed to the child.

Question 31

Tax Benefit Rule

Answer 31

-turns non-taxable items into taxable ones in specific situations.
-For instance, if you deduct medical expenses in December and get reimbursed by insurance in January, that reimbursement becomes taxable income because you received a tax benefit from deducting the expenses.

Question 32

Ownership Attribution Rule

Answer 32

-Ownership of an asset can be assigned to another person based on the situation.
-For example, even if a child technically owns an asset, the IRS can assign ownership to the parent, making them responsible for any taxes on the asset’s income.

Question 33

Hobby Loss Rule

Answer 33

-The IRS considers a business legitimate if its main goal is to make a profit.
-They typically expect a business to show a profit in 3 out of 5 years.
-But, there’s an exception for horse-related businesses, where they only need to show a profit in 2 out of 7 years.

Question 34

Forgiveness of debt

Answer 34

If someone owes money but isn’t bankrupt, and the creditor forgives the debt, the forgiven amount is treated as taxable income for the person who owed the debt.

Question 35

Constructive ownership Doctrine

Answer 35

-When dealing with stocks in closely held corporations, there’s a risk for individual taxpayers.
-The IRS considers individuals as owning stock belonging to their spouse, siblings, ancestors, and descendants.

Question 36

You won’t get a penalty for underpaying taxes if

Answer 36

You owe less than $1,000 in taxes after deductions.
You didn’t owe any taxes the year before on a return that covered the entire year.

Question 37

If you deduct medical expenses in December and get reimbursed by insurance in January what happens

Answer 37

Reimbursement becomes taxable income - tax benefit rule

Question 38

If one entity sells property to another controlled by the same person(s)…

Answer 38

the IRS might see it as an attempt to manipulate taxes, disallowing the transaction for tax purposes. SHAM TRANSACTION

Question 39

If a parent earns income can they give it to their child to avoid taxes?

Answer 39

No - assignment of income doctrine

Question 40

If a child technically owns an asset what can the IRS do?

Answer 40

The IRS can assign ownership to the parent, making them responsible for any taxes on the asset’s income

Question 41

What is one way a parent’s asset could be taxed under their child?

Answer 41

if the parent transfers the asset generating the income to the child, then the income will be taxed to the child.

Question 42

Undistributed income of a Personal Holding Company Income Test

Answer 42

Income Test: At least 60% of the company’s Adjusted Gross Income (AGI) must come from PHC income sources.

Question 43

Undistributed income of a Personal Holding Company Stock Test

Answer 43

More than 50% of the company’s stock must be owned by five or fewer individuals.

Question 44

How do you find the PHC’s undistributed income?

Answer 44

-Start with the corporation’s taxable income.
-Add back the Dividends Received Deduction.
-Subtract the income taxes payable and dividends paid to shareholders.

Question 45

What do you do once you find the total accumulated earnings?

Answer 45

Multiply this amount by 20% to find the accumulated earnings tax penalty.

Question 46

How do you calculate the PHC undistributed income tax penalty?

Answer 46

Multiply the undistributed income by 20%

Question 47

If you don’t file your tax return within 60 days after the due date what happens

Answer 47

You’ll face a minimum penalty of $100.

Question 48

What is the penalty for forgetting to file

Answer 48

The penalty starts at 5% of what you owe for the first month, and then increases by 5% each month, up to a maximum of 25%.

Question 49

If you filed jointly and your spouse didn’t know about the fraud what happens

Answer 49

They won’t be penalized (Innocent Spouse Rule).

Question 50

Personal Service Corporations (PSCs) can only save up to what?

Answer 50

Up to $150,000, while other corporations can save up to $250,000.