The Tax Practice Environment

1
The Tax PracticeEnvironment

• Chapter 2

2
Tax Practice

• Tax compliance
• Preparing returns
• Representation of client at IRS audit
• Tax planning
• Evaluating the tax consequences associated with a
  transaction and making recommendations that will
  achieve the desired objective at a minimal tax
  cost

3
Taxes and Cash Flow

• Tax cost is the increase in tax for the period
  and is a cash outflow
• Tax savings is a decrease in tax for a period and
  is a cash inflow
• Expense payment generates an outflow but
  deduction generates a tax reduction
• Reducing income taxes paid is a pure cash inflow
  because tax savings are not taxable

4
Taxes and Cash Flows

• Cash flows in future years are discounted to
  their present value so they can be compared using
  comparable dollars
• The marginal tax rate is the rate that applies to
  the next dollar of income and is used when
  evaluating transactions that increase or decrease
  taxable income

5
Tax Planning Strategies

• Timing income and deductions
• Defer recognition of income and accelerate
  recognition of deductions
• Income shifting
• Lower the total tax paid by splitting income
  among two or more taxpayers in the same family or
  between different entities owned by the same
  individual

6
Tax Planning Strategies

• Changing the character of income
• Structure transaction to qualify for favorable
  long-term capital gains rate
• Other factors affecting tax planning
• Discount rate
• Inflation
• Uncertainty
• Nontax (personal) objectives
• Cost of implementation

7
Judicial Doctrines

• Business purpose doctrine
• Transaction must have some business or economic
  purpose other than a tax avoidance motive
• Substance-over-form doctrine
• Taxability of a transaction is determined by the
  reality of the transaction, rather than its
  appearance
• Step transaction doctrine
• IRS can collapse a series of intermediate
  transactions into a single transaction to
  determine the tax consequences

8
Sources of Authority

• Primary authorities statutory, administrative,
  and judicial
• Secondary authorities tax services, books,
  journals, and newsletters
• Secondary authorities used to locate and
  interpret primary sources

9
Sources of Authority

• Statutory sources U.S. Constitution, tax
  treaties, and Internal Revenue Code
• Legislative process revenue bills begin in the
  House of Representatives
• Committee reports indicate the legislative intent
  of a bill
• House Ways Means Committee
• Senate Finance Committee
• Joint Conference Committee

10
Internal Revenue Code

• A tax bill passed by Congress is usually enacted
  as a revenue act that amends the existing
  Internal Revenue Code
• The Internal Revenue Code is divided into
  subtitles, chapters, subchapters, and sections
• Citations to the Code usually are to sections
  (Sec. or )

11
Administrative Sources

• Treasury regulations provide explanations,
  definitions, examples, and rules that explain the
  language in the Code
• The root element of the regulation number (to the
  right of the decimal) corresponds to the related
  section of the Code
• Revenue rulings are published by IRS to clarify
  ambiguous tax situations
• Letter rulings (PLR) can be requested by
  taxpayers who are uncertain about the correct tax
  treatment of a transaction

12
Judicial Sources

• Case first heard by a trial court (U.S. Tax
  Court, District Court, U.S. Court of Federal
  Claims)
• If either party is dissatisfied with the trial
  court decision, that party may ask an appellate
  court to review that decision
• The controversy may be appealed to and decided by
  the U.S. Supreme Court
• Each case has precedential value for future cases
  with the same fact pattern

13
Primary Sources of Authority
Legislative
Administrative
Judicial
14
Legislative Sources
Committee Reports Floor Statements
The Internal Revenue Code
15
Administrative Sources
Treasury Regulations
Revenue Rulings
Internal Revenue Service
Revenue Procedures
Letter Rulings other pronouncements
16
Judicial Sources
U. S. Court of Appeals for Federal Circuit
U. S. Court of Federal Claims
U. S. District Court U. S. Tax Court
The Supreme Court
U. S. Court of Appeals
17
Tax Research

• Purpose of research is to find solutions to tax
  problems
• Steps in research process
• Gather the relevant facts and identify the issues
• Locate and evaluate the relevant authority
• Communicate the recommendations

18
Tax Research

• Identifying the issues is the most difficult step
  for many new researchers
• Experienced professionals can state the relevant
  questions in terms of specific statutory
  authority and their questions frequently suggest
  the location of answers
• Tax services (reference services) can be used to
  locate the authorities (refer to Appendix A for
  step-by-step instructions)

19
Tax Research

• Reading the Code read every Code section that
  is applicable and watch for language that
  indicates quantities or time period
• Committee Reports it is usually best to start
  with the Joint Conference Committee report as
  that will indicate whether the House or Senate
  version was enacted
• Regulations check the publication date to see
  if updated for the current Code

20
Tax Research

• Revenue rulings reflect current IRS policy and
  carry considerable weight
• Letter rulings apply on the taxpayers to whom
  they were issued
• Acquiescence IRS acquiesces when it agrees with
  a court decision it has lost and it issues a
  nonacquiescence when it disagrees with a decision

21
Tax Research

• When a case involves a number of issues, the
  court will decide each issue separately
• The party who raises an issue generally has the
  burden of proof (usually the taxpayer except for
  fraud)
• The opinion is the courts statement of the
  reasons for its decision
• A reversal by an appellate court means that the
  party who won in the lower court now loses and
  the other party becomes the winner on that issue

22
Tax Research

• Under the Golsen rule, the Tax Court must follow
  the decision of the Court of Appeals that has
  direct jurisdiction over the taxpayer
• Citations for decisions should be checked in a
  citator to find out
• The decisions history
• What other courts have said about that case

23
Communicating the Recommendations

• Memo to the file
• Facts
• Issues
• Conclusions
• Discussion of reasoning and authorities
• Client letter

24
Filing a Tax Return

• Returns for individuals, partnerships, estates,
  and trusts due 15th day of 4th month (April 15)
• Corporate returns due 15th day of 3rd month
  (March 15)
• Extension of time to file
• Individuals 4 months 2 extra months
• Corporations 6 months

25
Penalties

• Failure-to-pay penalty
• ½ percent for each month (or part of month)
  payment is late (maximum 25)
• Failure-to-file penalty
• 5 percent per month (or partial month) up to 25
  maximum
• If both apply, rate is combined 5 percent for
  first 5 months and ½ percent thereafter (47½
  percent maximum)

26
Penalties

• No failure-to-file penalty if no tax is owned
• Fraudulent failure to file can increase late
  filing penalty to 15 a month (75 maximum)
• Installment agreement possible if unable to pay
  tax when due (late payment penalties apply)

27
Statute of Limitations

• Period of time beyond which legal actions or
  changes to the tax return cannot be made by
  taxpayer or IRS
• 3 years from date of filing or due date of return
  (whichever is later)
• 6 years if more than 25 of gross income
  inadvertently omitted
• No time limit for fraud

28
Statute of Limitations

• Refund claims must be initiated by taxpayer
  within later of
• 3 years of filing date for return
• 2 years from date tax is paid

29
Selecting Returns for Audit

• Information document matching program
• Mathematical/clerical error program
• Unallowable items program
• Discriminant function (DIF) formula
• Information provided by informant
• Up to 10 reward
• Undercover operations

30
Audits and Appeals

• Types of Audits
• Correspondence audit
• Office audit
• Field audit
• 30-day letter
• 30 days to request conference with Appeals
  Division
• Appeals officer can consider hazards of litigation

31
Appeals

• 90-day letter (statutory notice of deficiency)
• File petition with Tax Court within 90 days
• Pay the tax can then go to court to sue for
  refund
• Take no action and be subject to IRS enforced
  collection procedures

32
Appeals

• Trial Courts
• Tax Court is the only court that does not require
  the taxpayer to first pay the tax and then sue
  for refund
• Small Case Division of the Tax Court can hear
  disputes not exceeding 50,000 (but no appeal)
• District Court and Court of Federal Claims cannot
  hear the case unless a suit for refund
• Appellate Courts - Circuit Court of Appeals and
  Court of Federal Claims
• Supreme Court chooses the cases it will hear
  and accepts very few tax cases

33
Taxpayer Penalties

• Noncompliance penalties
• 20 of tax underpayment for negligence
• 75 of tax underpayment for civil fraud
• Fines and prison for tax evasion (criminal fraud)
• Burden of proof is on IRS to establish beyond a
  reasonable doubt that the taxpayer committed fraud

34
Collection Procedures

• IRS sends bill to taxpayer
• If no response, letter demanding payment in 10
  days
• IRS can impose lien on taxpayers property and
  seize assets
• Offer in compromise
• Innocent spouse relief

35
Professional Responsibilities

• Avoidance versus evasion
• Preparer penalties
• Penalties may not be covered by malpractice
  insurance
• Penalties are not deductible
• Penalties may result in an IRS review of the
  preparers entire practice
• Criminal tax evasion penalties include fines and
  prison

36
Professional Responsibilities

• Tax professionals have responsibilities to both
  tax system and to clients
• Sources of Guidance
• Circular 230
• AICPA Code of Professional Conduct
• Statements on Standards for Tax Services

37
The End