Unit 1 Flashcards
Primary Sources of Authority
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).
Congress (source of authority)
Passes tax laws (legislative branch).
Treasury Dept (source of authority)
via IRS: Enforces tax laws (executive branch).
Secondary Sources
Explain and interpret the Internal Revenue Code (IRC).
Examples:
RIA (Research Institute of America)
CCH (Commerce Clearing House)
BNA (Bureau of National Affairs)
Treasury Relations carry what
carry the “full force and effect of the law”
Congressional Committee Reports
provide insight into Congress’s intent behind laws
Revenue Rulings
issued by the IRS, serve as precedent for taxpayers in similar scenarios
Technical Advice Memos (TAMs)
offer precedents for taxpayers
Private Letter Rulings
specific to the taxpayer they’re addressed to, lacking assurance of similar treatment for others.
Filing Requirements
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.
Document Matching Program
Compares IRS records like W-2s, 1099s, 1098s, with filed documents.
DIF (Discriminate Functions System program)
Matches return information to set norms.
TCMP (Taxpayer Compliance Measurement Program)
Randomly checks 50,000 returns, verifying each line item. Suspended since 1995, but active again since 2006 to establish norms and promote compliance.
Targeted programs
Focus on specific professions like wait-staff, hairdressers, real estate agents, and Schedule C income for sole proprietors.
Penalties applied only to C corp
Personal Service Corporations (PSC), Accumulated Earnings Tax (AET), and undistributed income from a Personal Holding Company (PHC) apply only to C Corporations.
Negligence
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.
Fraud
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).
Understatement of liability applies to
annual returns and quarterly estimates
Understatement of Liability
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.
Frivolous return
An example would be filing a return with “Go Pound Sand” written on the return. Penalty is $500.
Failure to file
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.
Preparer Penalties
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.
Accumulated Earnings Tax
-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.
How to find accumulated earnings tax
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.
Undistributed income of a Personal Holding Company
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.
Undistributed income of a PHC tax penalty calculation
-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.
Sham transaction doctrine
-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.
Step Transaction Doctrine
-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.
Substance over Form Doctrine
-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.
Assignment of Income Doctrine
-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.
Tax Benefit Rule
-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.
Ownership Attribution Rule
-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.
Hobby Loss Rule
-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.
Forgiveness of debt
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.
Constructive ownership Doctrine
-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.
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.
If you deduct medical expenses in December and get reimbursed by insurance in January what happens
Reimbursement becomes taxable income - tax benefit rule
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. SHAM TRANSACTION
If a parent earns income can they give it to their child to avoid taxes?
No - assignment of income doctrine
If a child technically owns an asset what can the IRS do?
The IRS can assign ownership to the parent, making them responsible for any taxes on the asset’s income
What is one way a parent’s asset could be taxed under their child?
if the parent transfers the asset generating the income to the child, then the income will be taxed to the child.
Undistributed income of a Personal Holding Company Income Test
Income Test: At least 60% of the company’s Adjusted Gross Income (AGI) must come from PHC income sources.
Undistributed income of a Personal Holding Company Stock Test
More than 50% of the company’s stock must be owned by five or fewer individuals.
How do you find the PHC’s undistributed income?
-Start with the corporation’s taxable income.
-Add back the Dividends Received Deduction.
-Subtract the income taxes payable and dividends paid to shareholders.
What do you do once you find the total accumulated earnings?
Multiply this amount by 20% to find the accumulated earnings tax penalty.
How do you calculate the PHC undistributed income tax penalty?
Multiply the undistributed income by 20%
If you don’t file your tax return within 60 days after the due date what happens
You’ll face a minimum penalty of $100.
What is the penalty for forgetting to file
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 filed jointly and your spouse didn’t know about the fraud what happens
They won’t be penalized (Innocent Spouse Rule).
Personal Service Corporations (PSCs) can only save up to what?
Up to $150,000, while other corporations can save up to $250,000.
