The Tax Practice Environment

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The Tax PracticeEnvironment

• Chapter 2

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Tax Practice

• Tax compliance
• Preparing returns
• Representing clients 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

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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

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Cash Flows Present Value

• Cash flows in future years are discounted to
  their present value so they can be compared in
  todays dollars
• When marginal tax rates are expected to change
  from year to year, timing transactions
  accordingly will minimize tax costs and maximize
  tax savings

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Tax Planning Strategies

• Timing income and deductions
• General rule - defer recognition of income and
  accelerate recognition of deductions
• Recognize income in year with lowest marginal tax
  rate
• Deduct expenses in year with highest marginal tax
  rate

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Tax Planning Strategies

• Shifting income
• Splitting income among two or more taxpayers in
  the same family or between different entities
  owned by the same individual may lower the total
  tax paid (progressive tax rate system)
• Changing the character of income
• Structure transaction to avoid being taxed at
  ordinary income rates (up to 35) to qualify
  for favorable long-term capital gains rate (15)

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Tax Planning Strategies

• Other factors affecting tax planning
• Discount rate (cost of capital)
• Inflation
• Uncertainty
• Nontax (personal) objectives
• Cost of implementation
• Planning costs vs. Tax savings

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Judicial Doctrines

• Business purpose doctrine
• A transaction must have a business or economic
  purpose other than tax avoidance
• 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

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Primary Sources of Authority
Statutory
Administrative
Judicial
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Statutory Sources of Authority

• U.S. Constitution
• Internal Revenue Code
• Tax treaties
• Committee reports that indicate the legislative
  intent of a bill
• House Ways Means Committee
• Senate Finance Committee
• Joint Conference Committee

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Tax Legislative Process

• Tax bill introduced in the House
• Referred to the House Ways and Means Committee
• Submitted to the full House to be debated under
  closed rule
• If passed, bill is sent to the Senate
• Referred to the Senate Finance Committee

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Tax Legislative Process

• Submitted to the Senate to be debated under open
  rule
• If House and Senate versions differ, referred to
  a Joint Conference Committee where a compromise
  version of the bill is developed
• If compromise version passed by both houses of
  Congress, the bill is submitted to the President
  for his signature

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Internal Revenue Code

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

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Administrative Sourcesof Authority
Treasury Regulations
Revenue Rulings
Revenue Procedures
Letter Rulings other pronouncements
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Judicial Sources
U. S. Court of Appeals for Federal Circuit
U. S. Court of Federal Claims
U. S. District Court
The Supreme Court
U. S. Court of Appeals
U. S. Tax Court
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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

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Filing Deadlines for Tax Returns

• 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)
• Extensions of time to file
• Individuals 4 months 2 extra months
• Corporations 6 months

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Filing 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) return is
  late (maximum 25)
• If both apply, rate is combined 5 percent for
  first 5 months and ½ percent thereafter (47½
  percent maximum)

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Filing Penalties

• No failure-to-file penalty if no tax is owed
• Minimum 100 failure-to-file penalty if return
  more than 60 days late
• 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)

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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 is
  inadvertently omitted (not excess deductions)
• No time limit for fraudulent returns (burden of
  proof is on the IRS)

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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

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Selecting Returns for Audit

• Information Document Matching Program
• Computerized matching of information on return
  with data from 3rd parties (W-2 from employer)
• Mathematical/Clerical Error Program
• Unallowable Items Program

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Selecting Returns for Audit

• Discriminant function (DIF) formula
• Rating for audit potential
• High DIF score high probability of adjustment
• Information provided by informant
• Up to 10 reward (fully taxable)
• Undercover operations

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Audits

• Types of Audits
• Correspondence audit verify one or two items in
  question by mail
• Office audit requires some analysis IRS
  judgment through interview
• Field audit typically limited to examination of
  business returns

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Appeals Procedure

• 30-day letter
• 30 days to request conference with Appeals
  Division
• Appeals officer can consider hazards of
  litigation
• 90-day letter (statutory notice of deficiency)
• File petition with Tax Court within 90 days
• Pay the tax, then go to court to sue for refund
• Take no action and be subject to IRS enforced
  collection procedures

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Going to Court

• Trial Courts
• Tax Court - only court that does not require the
  taxpayer to first pay the tax and 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 suing 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

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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

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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

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Professional Responsibilities

• Avoidance (legal) vs. evasion (illegal)
• Preparer penalties
• May not be covered by malpractice insurance
• Non-deductible
• May result in an IRS review of the preparers
  entire practice
• Criminal tax evasion penalties include fines and
  prison

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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

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Tax Research

• Appendix 2A

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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

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Identify the Issues

• Identifying the issues and stating the critical
  tax questions is the most difficult step for many
  new researchers
• Experienced professionals can review a situation
  and state the relevant questions in terms of
  specific statutory authority
• Questions frequently suggest the location of
  answers

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Locate Evaluate Authorities

• Tax services (reference services) can be used to
  locate the authorities
• Internal Revenue Code read every Code section
  that is applicable and watch for language that
  indicates quantities or a 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 latest amendments to the Code

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Locate Evaluate Authorities

• Revenue rulings reflect current IRS policy and
  carry considerable weight
• Letter rulings binding only for taxpayers to
  whom they were issued
• Court Cases
• Tax Court
• Federal District Courts
• U. S. Court of Federal Claims
• Appellate Courts

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Evaluating Judicial Authorities

• 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

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Evaluating Judicial Authorities

• Acquiescence IRS agrees with a court decision
  it has lost
• IRS issues a nonacquiescence when it disagrees
  with a 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

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Evaluating Judicial Authorities

• 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

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Completing Your Research

• When to stop searching
• What is level of authority located?
• Is position supported in IRS rulings?
• Do different sources cite the same authority?

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Communicating Recommendations

• Memo to the file usually contains
• Restatement of relevant facts
• Issues addressed
• Conclusions (researchers recommendations)
• Discussion of reasoning and authorities
• Client letter

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The End