To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 17 TAX PRACTICE AND ETHICS SOLUTIONS TO PROBLEM MATERIALS Question/ Problem 10 11 12 13 14 15 16 17 18 19 20 *21 *22 23 *24 *25 26 27 28 *29 30 31 *32 *33 Learning Objective LO LO LO LO LO LO LO LO LO LO LO LO 3, LO LO LO LO LO LO LO LO LO LO 4, 5, LO 4, LO LO LO LO LO LO 6, LO LO LO LO Topic Tax administration and the client Role of the IRS Rates of audit The tax gap Organization of the IRS Chief Counsel Precedential value of letter ruling Burden of proof Assessment, lien, seizure Audit selection Audit cycles Audit strategy Types of audit Small Cases Division Offers in Compromise IRS interest Penalty terminology Valuation penalties Valuation penalties Penalty for improper refund Estimated taxes Taxpayer penalties and interest Tax administration and practice Withholding taxes Statutes of limitations Tax preparer behavior Circular 230 Practice before the IRS Preparer penalties Ethical restrictions on tax practitioners Interest charged Failure to file penalty Failure to pay penalty Status: Present Edition New New New Unchanged Updated Unchanged New New Unchanged New New New Unchanged Unchanged Unchanged Unchanged Modified Modified Unchanged Unchanged New Modified Modified Unchanged Unchanged Unchanged Unchanged Unchanged New Unchanged Updated Modified Modified Q/P in Prior Edition 13 14 15 16 17 18 19 20 22 23 24 25 26 27 28 30 31 32 33 Instructor: For difficulty, timing, and assessment information about each item, see p 17-3 17-1 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-2 Question/ Problem 2012 Corporations Volume/Solutions Manual Learning Objective *34 *35 36 37 LO LO LO LO 38 *39 40 41 42 43 44 45 LO LO LO LO LO LO LO LO 46 LO 47 48 49 50 51 52 53 54 55 LO LO LO 5, LO LO LO LO LO LO Topic Computation of penalties Failure to file and pay penalties Failure to file and pay penalties Failure to file and pay penalties; overall limitation; reasonable cause due to reliance on CPA Fraud and negligence penalties imposed Overvaluation penalty Undervaluation penalty Appraiser’s penalty Penalty for improper refund Civil fraud Determining estimated payments: individual Determining estimated payments: corporation Penalty for failure to remit withholding deposits Statute of limitations Statute of limitations; gross income omission Refund claim compliance Statute of limitations; refund claim Circular 230; representation before the IRS Preparer penalties Preparer penalties Preparer penalties AICPA Statements on Standards for Tax Services Status: Present Edition Q/P in Prior Edition Unchanged Modified Modified Modified 34 35 36 37 Modified Unchanged Unchanged Modified Modified Modified Modified Modified 38 39 40 41 42 43 44 45 Unchanged 46 Unchanged Unchanged Modified Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged 47 48 49 50 51 52 53 54 55 *The solution to this problem is available on a transparency master Instructor: For difficulty, timing, and assessment information about each item, see p 17-3 Research Problem 10 11 12 Topic Reasonable cause Statute of limitations Failure to file penalty Tax preparers Financial hardship Internet activity Internet activity Internet activity Internet activity Internet activity Internet activity Internet activity Status: Present Edition New New Unchanged Unchanged Unchanged Unchanged Modified Unchanged Unchanged Unchanged Modified New Q/P In Prior Edition 10 11 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Tax Practice and Ethics Question/ Problem Difficulty Easy Easy Easy Easy Est’d completion time Assessment Information AICPA* AACSB* Core Comp Core Comp 5 5 FN-Risk Analysis FN-Reporting FN-Reporting FN-Reporting Easy Easy Medium 5 10 FN-Reporting FN-Risk Analysis FN-Research Easy Medium 10 FN-Risk Analysis FN-Risk Analysis 10 11 12 13 14 Easy Easy Easy Easy Easy 5 5 15 Easy 16 17 Easy Easy 5 18 Easy 19 20 Easy Easy 10 21 Medium 10 22 Medium 10 23 Medium 15 24 25 Easy Medium 10 26 Medium 10 27 28 Easy Easy 10 29 Easy 30 31 Easy Easy 10 17-3 FN-Risk Analysis FN-Risk Analysis FN-Risk Analysis FN-Risk Analysis FN-Research | FN-Risk Analysis FN-Reporting | FN-Risk Analysis FN-Measurement FN-Measurement | FN-Risk Analysis FN-Measurement | FN-Risk Analysis FN-Measurement FN-Measurement | FN-Risk Analysis FN-Measurement | FN-Risk Analysis FN-Measurement | FN-Risk Analysis FN-Research | FN-Risk Analysis FN-Reporting FN-Risk Analysis FN-Research | FN-Risk Analysis FN-Risk Analysis FN-Research | FN-Risk Analysis FN-Risk Analysis FN-Risk Analysis FN-Measurement Analytic Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Communication | Analytic Analytic Communication | Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic Communication | Analytic Analytic Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-4 2012 Corporations Volume/Solutions Manual Question/ Problem Difficulty Est’d completion time 32 33 34 35 36 37 Easy Easy Medium Medium Easy Medium 10 10 10 10 10 38 39 40 41 42 43 44 45 46 Easy Medium Medium Easy Easy Easy Medium Medium Hard 10 10 5 10 10 15 47 Easy 10 48 49 Medium Medium 10 10 50 Medium 10 51 52 Easy Medium 10 53 54 Medium Easy 15 10 55 Medium 10 Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement | FN-Risk Analysis FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement | FN-Risk Analysis FN-Measurement | FNReporting FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Risk Analysis FN-Measurement | FN-Risk Analysis FN-Risk Analysis FN-Measurement | FN-Risk Analysis FN-Risk Analysis Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Communication | Analytic Analytic Analytic Analytic | Reflective Thinking Communication | Analytic Analytic Analytic Analytic Analytic Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Tax Practice and Ethics 17-5 CHECK FIGURES 31.c 32.b 33.a 34 35.b 36 37.a 38 39.d 39.e 39.f 40.b 40.c 40.d 41.b 42.a percent $750 penalty $60 penalty Failure to file penalty $1,350 $10,600 $900 $2,375 failure to pay penalty $30,000 penalty for negligence $0 penalty due $7,000 $84,000 $0 penalty due $9,000 $63,000 $6,250 $80,000 43 44.a 45.a 45.b 47.a 47.b 47.c 48.a 48.c 49.a 52.a 52.c 53.d 53.e 54.c $7,500 fraud, $22,000 negligence $10,125 each $42,500 each $38,250 each None Seven years Six years $266,250 No statute of limitations $10,000 $0 $1,000 $250 penalty, no realistic possibility Probably none $50,000 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-6 2012 Corporations Volume/Solutions Manual DISCUSSION QUESTIONS To render valuable services to the client who is or could be under the audit scrutiny of the IRS, the practitioner must appreciate all of the following • The elements of the Treasury’s tax administration process and opportunities for appeal within the structure of the IRS • The extent of the negative sanctions that can be brought to bear against taxpayers whose returns are found to have been inaccurate • Pertinent ethical and professional constraints on the advice given and actions taken by the tax adviser on behalf of the client, within the context of an adversarial relationship with the IRS p 17-2 The IRS, a subsidiary agency of the Department of the Treasury, is responsible for providing adequate information, in the form of publications and forms with instructions, to taxpayers so that they can comply with the laws in an appropriate manner The IRS also identifies delinquent tax payments and carries out collection and assessment procedures under the constitutional restrictions offered by due process pp 17-3 and 17-4 About 1% of all individual tax returns are audited in a given tax year However, certain types of both taxpayers and income—including, for instance, high-income individuals (about 4%), cash-oriented businesses, real estate transactions, and estate- and gift-taxable transfers (as high as 20%)—are subject to much higher probabilities of audit The ethical tax professional does not “play the audit lottery” and lower his/her reporting standards because of a perception that such actions “will not be caught.” p 17-3 The tax gap is an indicator monitored by politicians and the IRS It measures the difference between actual Federal income tax collections and the amount that the IRS projects should be collected if there is full compliance with all income tax laws By most estimates, the annual tax gap is about $300 billion The issues that arise concerning the tax gap include the following • What means should be employed to reduce the gap? Should the IRS hire more enforcement personnel and what items (e.g., income, deductions, or credits) should they examine? • How large can the IRS become without a public reaction to a Big Brother atmosphere and an abuse of confidential information that can result from too much audit activity? • Why should the government not attempt to close the tax gap in full and thereby eliminate most of the annual budget deficit? p 17-3 a Commissioner b Chief Counsel © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Tax Practice and Ethics c 17-7 Wage and Investment, Small Business and Self-Employed, Large and International Business, Tax Exempt/Government Entities Figure 17.1 The Chief Counsel is responsible for the following functions, among others • Provide legal advice to the IRS • Provide guidance to the public as to the enforcement and administration of the Federal tax laws • Establish national uniform interpretive positions regarding the Federal tax laws • Draft guidance materials by which the tax law is applied, for the IRS and for the public • Issue technical rulings as requested by taxpayers • Represent the IRS in all Tax Court litigation p 17-4 TAX FILE MEMORANDUM November 3, 2011 From: Rick J Taylor Re: Precedential value of letter ruling received The receipt of an unfavorable letter ruling does not force negative tax consequences upon a taxpayer The nature of the ruling process is more multidimensional in application A letter ruling represents the current opinion of the IRS relative to the consequences of a narrowly defined set of facts If the terms of the proposed transaction are altered, the holding might be irrelevant Rulings frequently are declared obsolete or are superseded by new rulings as the tax law changes However, modification of a ruling generally is not applied retroactively to the taxpayer who received the ruling initially, if it was relied on in good faith in a transaction substantially similar to that described in the ruling The IRS may revoke any ruling if, upon subsequent audit, an agent finds a misstatement or omission of facts or substantial discrepancies between the facts as described in the ruling request and those encountered in the transaction pp 17-4 and 17-5 The IRS bears the burden of proof in the context of a tax dispute that is being litigated To maintain this position, the taxpayer must have cooperated with the IRS concerning requests for documents, meetings, and other sources of evidence p 17-6 After completing the audit, the IRS follows these steps • Assess the tax deficiency after the 90-day letter has expired © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-8 2012 Corporations Volume/Solutions Manual • Demand payment of the assessed amount • If collection is in doubt, a jeopardy assessment may be filed • Lacking collection from the taxpayer, the IRS places a lien on all of the assets This may include an attachment/garnishment of wages paid • The IRS then will seize specific assets until the assessment is satisfied pp 17-6 and 17-7 10 The IRS does not reveal the details of its audit selection process Tax returns for audit are chiefly selected by use of the Discriminant Inventory Function (DIF), a software program that is based on data produced by the National Research Project The DIF identifies taxpayers and tax return items that are susceptible to error and produce the most revenue per tax return audited Other means by which tax returns are selected for audit include the following • Information from informants and whistleblowers • Claims for refund • A mismatching of the tax return with information returns • Special IRS programs that target the tax returns of a certain industry, a certain tax return item, or a certain taxpayer group • Information from other sources, such as other Federal agencies, state and local government audits, and general news items pp 17-7 and 17-8 11 Tax return processing and audit selection are two different functions of the IRS, and they operate independently of each other As a practical matter, most individual returns are examined about two years from the date of their filing No conclusions can be drawn prior to the third year after the filing date, though, in light of the statute of limitations Mathematical errors and document matching concerns are the only IRS-initiated corrections that are likely to occur within one year of the date the return is filed Large corporations are audited every year Thus, a taxpayer should not feel ‘‘too comfortable” with respect to avoiding an audit until enough time passes Two months is not enough time, even if a refund check has been received p 17-8 12 Settlement of factual issues with the IRS audit agent generally is desirable, since further administrative appeals and litigation can be a time-consuming and costly process An agent must adhere strictly to IRS policy as reflected in published rulings, regulations, and other IRS releases Since he or she usually cannot resolve an issue based upon the hazards of litigation, it may be desirable to resolve factual issues at the agent level and to attempt to reach a settlement of the remaining unresolved issues with the Appeals Division © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Tax Practice and Ethics 17-9 One problem with not disposing of a case at the agent level is that new issues may be raised during Appeals or litigation, where the return will come under closer scrutiny p 17-10 13 The most common types of audit are the following Type of Audit Correspondence Office Field Example Math error involved A deduction not documented Business taxpayer, workpaper review Frequency 69% 3% 28% Table 17.1 14 The Small Cases Division can be attractive as part of one’s litigation strategy, because it hears cases where not more than $50,000 of tax is due to the government under a statutory notice of deficiency Rules of evidence are relaxed somewhat, and taxpayers often represent themselves before the Division And the taxpayer need not remit any tax, penalty, or interest until the court issues its opinion Decisions from Small Cases technically not create precedent for other taxpayers Decisions from Small Cases are not appealable by either party Commercial publishers provide summaries of the decisions, but there is no other full reporting of Small Cases decisions Thus, the taxpayer who can develop a good case in support of his or her return position, on his or her own or with the assistance of a low-cost counsel such as a university tax clinic or a relative, and who would not consider making an appeal from a negative decision for cost or other reasons, is an ideal candidate for the Small Cases Division p 17-13 15 An offer in compromise will be considered if any of the following circumstances is present • There is doubt as to the amount of tax due (e.g., disputed issues) • There is doubt that the tax can be collected (e.g., low net worth or earnings capacity) • Payment of the tax would present an economic hardship for the taxpayer (e.g., the taxpayer is ill and cannot replace the tax payment with new earnings) p 17-13 16 Interest rates for Federal taxes are determined quarterly, and the interest is compounded daily The rates are based on short-term (three years or less) U.S Treasury market interest rates, as published in Revenue Rulings Interest on an underpayment usually accrues from the unextended due date of the tax return, not the date on which a closing settlement is signed pp 17-14 and 17-15 17 Civil penalties usually result from an IRS audit and, in addition to taxes plus interest, impose a monetary fine © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-10 2012 Corporations Volume/Solutions Manual Criminal penalties result from the general criminal justice system (usually involving government personnel from outside the IRS) and can result in taxes, interest, and a fine In addition, the taxpayer may receive a jail sentence An ad valorem penalty is computed as a percentage of the disputed tax, or some other verifiable amount—gross income or fees collected An assessable penalty typically entails a flat dollar amount A penalty is an addition to the tax liability; it is not a business or personal expenditure Thus, the taxpayer cannot deduct a tax penalty when it is paid or accrues p 17-16 18 The following valuation penalties are likely to apply a Overvaluation b Overvaluation c Undervaluation pp 17-18 and 17-19 19 The valuation penalties are computed as 20% of the tax reduction due to the misstatement The penalty rate is doubled to 40% if the valuation error is found to be a gross misstatement of the correct value There are minimum penalties and thresholds that relate to the filing status of the taxpayer The penalty can be waived if reasonable cause is shown pp 17-17 to 17-19 20 The IRS still may assess a penalty of 20% of the $80,000 disallowed refund, or $16,000 The penalty is waived if Yonkers can show that it had a reasonable basis for making the refund claim (i.e., that there was at least a 20% chance that a court would allow the full $100,000 refund) Yonkers should be prepared to demonstrate this reasonable basis if the IRS assesses the penalty p 17-20 21 Because the withholding shortfall exceeds $1,000, Cameron must either: • increase the withholding on his earnings for the rest of the year, or • remit estimated tax before the fifteenth day of the month after his tax year-end (January 15 for a calendar-year individual) Total payments before filing the Form 1040 must equal at least 90% of the current-year tax or 100% of last year’s tax (110% of last year’s tax for high-income individuals) Underpayment penalties are computed for each quarter of the tax year, and withholdings are assumed to have been paid in equally during the year p 17-20 22 a False The government is required to pay interest at the applicable Federal rate to any taxpayer who has made an overpayment of tax Interest on the overpayment begins to accrue from the later of 45 days after the unextended due date of the return or 45 days after the return actually is filed However, if the refund is not made within this 45-day period, interest begins to accrue from the due date of the return p 17-15 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Tax Practice and Ethics 23 17-11 b True Prior to the time that the case is referred to the Justice Department for prosecution or defense, the IRS can compromise on any civil or criminal case that does not involve illegal drugs However, the IRS will not enter into a compromise with a taxpayer if the liability has been established by a valid judgment, and there is no doubt as to the IRS’s ability to collect the amounts that are due p 17-13 c True Although the general rule is that assessment must be made within three years from the later of the date that the return actually is filed or the unextended due date of the return, the three-year period is extended when: • there is a substantial understatement of gross income (greater than 25%); • the taxpayer files no return or files a false or fraudulent return with the intent to evade tax; or, • the IRS and the taxpayer agree to extend the statute of limitations period with respect to a return that is under audit pp 17-22 and 17-23 d False If a tax return has not been filed, the statute of limitations period has not yet begun Essentially, the statute of limitations is unlimited in this case p 17-23 a An offer in compromise is the means by which the taxpayer offers to reduce a liability resulting from an alleged violation of laws or failure to pay an internal revenue liability It is binding on the IRS and the taxpayer, because it is a legally enforceable promise that cannot be rescinded, unless there has been a misrepresentation of the assets of the taxpayer by falsification or concealment, or a mutual mistake relative to a material fact Absent grounds for rescission, a taxpayer who has entered into a valid compromise may not subsequently prosecute a claim for refund Generally, an offer in compromise is used in collection cases to settle a tax liability for less than the assessed amount (e.g., where the taxpayer is not likely to pay the full amount of deficiency) A closing agreement is a formal written agreement that is made between a taxpayer and the IRS It is the only agreement that is binding on the IRS by operation of statute (an offer in compromise is binding under contract, rather than tax law) Unlike an offer in compromise, a closing agreement is final and conclusive on both the government and the taxpayer, unless there is a showing of fraud, malfeasance, or a misrepresentation of a material fact, by either party The IRS discourages the use of closing agreements because of their finality Moreover, the IRS’s closing agreement procedures are restrictive and cumbersome pp 17-13 and 17-14 b If a taxpayer fails to pay either a tax that is shown on his or her return, or an assessed deficiency, within ten days of an IRS notice and demand, a penalty is imposed The penalty is 0.5% of the required liability, after adjusting for any prior payments and credits, for each month (or fraction thereof) that the tax is not paid The maximum penalty that may be imposed is 25% of the outstanding tax If a taxpayer fails to file a required return, a penalty is imposed unless it is shown that the failure is due to some reasonable cause, and not the taxpayer’s willful neglect The penalty is 5% of the amount of the tax, less any prior payments and credits, for each month (or fraction thereof) that the return is not filed The maximum penalty that may be imposed is 25% The penalty is increased to 15% per month, up to a maximum of 75%, if the failure to file is fraudulent © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-12 2012 Corporations Volume/Solutions Manual The failure to file penalty is reduced by the 0.5% failure to pay penalty, for any month in which both apply The failure to file penalty can be avoided if an extension of the return’s due date is granted by the IRS, and the IRS can waive the concomitant failure to pay penalty, as a means of encouraging more taxpayers to file on a more timely basis pp 17-16 and 17-17 c A 30-day letter is a document that formally notifies the taxpayer of the examiner’s findings, requests that the taxpayer agree to the proposed adjustments, and informs the taxpayer of his or her appeal rights If no response to this notice is received within 30 days, the taxpayer will be sent a statutory notice of deficiency (“90-day letter”), which permits him or her a pre-payment Tax Court review of the deficiency A 90-day letter is a statutory notice of deficiency that is issued by the District Director when the taxpayer and the IRS cannot agree on the proposed adjustments after an appeals conference or when the taxpayer has not responded in a timely manner to a 30day letter Once the statutory notice of deficiency is mailed, the taxpayer has 90 days to file a petition with the Tax Court for a redetermination of the deficiency If this period is allowed to expire, the taxpayer still can pay the deficiency and file a suit for refund in the appropriate District Court or the U.S Court of Federal Claims Figure 17.2 d Neither negligence nor fraud is defined by the Code or the Regulations However, both terms have been defined by the courts Negligence has been defined as a lack of due care or failure to what a reasonable and prudent individual would under similar circumstances The negligence penalty usually is applied to taxpayers who fail to report gross income, overstate their deductions, or fail to keep adequate books and records, provided that they are not found to have held a specific intent to evade the tax Fraud is described as actual, intentional wrongdoing The intent required is the specific purpose to evade a tax believed to be owing This definition has been expanded to include acts that are done without a bad or evil purpose It is the taxpayer’s deceptive or misleading conduct that distinguishes fraud from mere negligence pp 17-18 and 17-20 e Tax penalties may involve both criminal and civil offenses Criminal tax penalties are imposed only after the usual criminal process, in which the taxpayer is entitled to the same constitutional guarantees that are given to nontax criminal defendants A criminal tax penalty is assessed because of repeated and willful attempts to understate one’s tax liability Usually, a criminal penalty provides for imprisonment Civil tax penalties are collected in the same manner as other taxes, and usually only provide for monetary fines A taxpayer may be liable for both criminal and civil sanctions Criminal and civil penalties are not mutually exclusive; thus, a taxpayer who is convicted or acquitted of a criminal tax offense, also may be liable for a civil penalty pp 17-20 and 17-22 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Tax Practice and Ethics 24 17-13 One or more of the following penalties could apply • At IRS interest rates for a failure to pay adequate and timely amounts of estimated taxes §§ 6654 and 6655 • $500 when an employee uses false information to claim withholding allowances Đ 6682 15% of unpaid amounts when an employer does not remit withheld Federal income and payroll taxes Willful actions of this sort can lead to criminal penalties and a 100% penalty §§ 6656, 6672, and 7202 pp 17-20 and 17-21 25 Statutes of limitations form an outer boundary for the appeals process, for both taxpayer and government The statutes tend to recognize that the mere passage of time affects adversely the administration of the tax law, as evidence is lost and witnesses’ memories grow dim The statutes bind both parties, such that restrictions as to issues in dispute and the means by which to support them can aid both sides in the determination of a final tax The statutes may bind the parties unduly, though, when workloads, work stoppages, difficulties in obtaining information in a global environment, and other factors by their nature slow down the enforcement process Certain exceptions exist in the law to allow additional time where information might be difficult to discover (e.g., worthlessness of securities, failure to file any return) The tax statute can be extended in most cases by mutual consent, although this power can be abused by the government in its scheduling of audit activity and by the taxpayer in its process of disclosing information to the Treasury p 17-22 26 Tax compliance behavior is regulated by Congress (through the penalty provisions in the Code as to both taxpayers and tax preparers), the Treasury (through Circular 230), and the professional organizations of tax professionals (like the AICPA, the ABA, and the EA associations) These provisions often overlap, and they sometimes are in conflict—the penalty provisions seem to apply both a ‘‘reasonable basis’’ and a ‘‘realistic possibility’’ standard in taking tax return positions—as they evolve at different paces The AICPA adopted a ‘‘realistic possibility’’ standard late in 2000, and the ABA has not yet formally done so, but the Code has included this language since the mid-1980s The Code’s disclosure standards for tax preparers (more likely than not to be upheld by a court) are higher than those for individual taxpayers (substantial authority for the tax return position) pp 17-24 to 17-33 27 a Acceptable, as long as the position is not frivolous If there is no realistic possibility of the position being upheld in court upon a later review, it must be disclosed on the return using Form 8275 b Unacceptable The tax professional is required to apply best industry practices in preparing returns c Unacceptable The tax professional must provide information to the IRS in a timely fashion and cooperate in the proceeding © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-14 2012 Corporations Volume/Solutions Manual d Unacceptable The tax professional must exercise due diligence in preparing and filing tax returns This includes maintaining a satisfactory level of continuing education e Unacceptable The tax professional may not charge an unconscionable fee f Acceptable Contingent fees are allowed for a tax professional’s services as to audited and amended returns, but not for preparing the original returns g Probably unacceptable, as the parties are likely to have a conflict of interest pp 17-25 and 17-26 28 Only the tax professionals in items a and c are subject to the preparer penalties p 17-27 and Circular 230 29 Some of the more important tax preparer penalties provided by the Code include the following $250 $1,000 $50 $50 $500 Tax understatement due to taking an unrealistic position Tax understatement due to willful and reckless conduct Failure to sign a return or to provide the tax preparer’s identification number Failure to furnish a copy of the return to the taxpayer Endorsement of the client’s refund check pp 17-27 to 17-29 30 a IRS Circular 230 AICPA Code of Professional Conduct AICPA Statements on Standards for Tax Services IRC penalty provisions b IRS Circular 230 IRC penalty provisions c IRS Circular 230 Codes and interpretations of the ABA and state bar associations IRC penalty provisions d IRS Circular 230 EA Code of Professional Ethics IRC penalty provisions e IRS Circular 230 IRC penalty provisions pp 17-24 to 17-33 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Tax Practice and Ethics 17-15 PROBLEMS 31 The interest rate before compounding for the first quarter of 2011 is as follows a 3% b 3% c 3% d 2% p 17-15 32 The failure to file penalty is 5% per month of the tax due, with a $135 minimum penalty and a maximum penalty of 25% In the case of fraud, the penalty rate is tripled a 5% × months × $1,000 tax due = $100, but apply the larger $135 minimum penalty b 5% × months × $3,000 tax due = $750 penalty c 5% × months maximum × $4,000 tax due = $1,000 penalty d A partial month counts as a full month Penalty = 5% × months × $3,000 tax due = $450 e 15% × months × $4,000 tax due = $3,000 penalty f 15% × 10 months × $15,000 tax due = $22,500, but limited to 75% of the tax due = $11,250 p 17-16 33 The failure to pay penalty is 0.5% of the tax due, with a maximum penalty of 25% a 0.5% × months × $3,000 tax due = $60 penalty (no minimum amount) b 0.5% × 10 months × $4,000 tax due = $200 penalty c 0.5% × 50 months maximum × $5,000 tax due = $1,250 penalty p 17-16 34 Failure to Pay Underpayment Penalty rate Penalty per month outstanding Months late Penalty $30,000 × 0.005 $ 150 ×7 $ 1,050 Failure to File Underpayment Penalty rate Penalty per month outstanding Months late Penalty before reduction $30,000 × 0.05 $ 1,500 ×1 $ 1,500 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-16 2012 Corporations Volume/Solutions Manual Less: Concomitant failure to pay penalty (1 month × $150) Penalty (150) $ 1,350 The failure to file penalty applies from the extended due date of the return, for one month in this case Lacking IRS approval, the automatic six-month extension of time to file does not extend the time to pay the tax Thus, the failure to pay penalty applies for parts of seven months Example 12 35 a Olivia is liable for both the failure to file penalty (she did not apply for and obtain an extension of time for filing her return) and the failure to pay penalty (a portion of her tax liability was unpaid as of April 15, the statutory due date for her return) Her “I was too busy” excuse would not qualify as reasonable cause to exempt her from the two penalties pp 17-16 and 17-17 b For these purposes, she is considered to be eight months late in filing her return [April 15 to December 12 (part of a month counts as a full month)] The penalty for failure to file is 5% per month (up to a maximum of 25%); the penalty for failure to pay is 1/2 of 1% per month (up to a maximum of 25%) During any month in which both penalties apply, the penalty for failure to file is reduced by the penalty for failure to pay Calculations, based on tax due balance of $10,600, are as follows Failure to pay penalty (1/2 of 1% per month × months) Plus: Failure to file penalty (5% per month × months)* Less: Failure to pay penalty for same period Total penalties $10,000 (1,000) $ 1,600 9,000 $10,600 *As the failure to file penalty cannot exceed 25%, the limit is months (i.e., months × 5% = 25%) This problem does not address the issue of the penalty for underpayment of estimated tax If such penalty applies, it also is considered an addition to the tax for purposes of any penalties (or interest) due Example 12 36 Failure to pay penalty (1/2 of 1% × $6,000) × months Plus: Failure to file penalty (5% × $6,000) × months Less: Failure to pay penalty for same period Total penalties $900 (90) $ 90 810 $900 Example 12 37 a Failure to pay penalty (1/2 of 1% × $25,000) × 19 months Plus: Failure to file penalty (5% × $25,000) × months Less: Failure to pay penalty for same period Total penalties $2,375 $6,250 (625) 5,625 $8,000 The failure to file penalty cannot exceed a total of 25% Consequently, this penalty is capped after months (i.e., 5% × months = 25%) The failure to pay penalty also is © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Tax Practice and Ethics 17-17 limited to a total of 25% (At the rate of 1/2 of 1% per month, such penalty can continue to run for as long as 50 months.) Example 12 b 38 Reliance by a taxpayer on a CPA to file generally does not constitute reasonable cause so as to avoid the failure to file and pay penalties p 17-17 Penalty attributable to civil fraud (75% × $50,000) Penalty attributable to negligence (20% × $150,000) Total fraud and negligence penalties $37,500 30,000 $67,500 Some of the underpayment ($50,000) is not subject to any penalty, but tax and interest still would be due If the underpayment is partially attributable to negligence and partially attributable to fraud, the fraud penalty is applied first Example 14 39 a $0 Reported valuation ($50,000) is not at least 150% of correct value ($40,000) b $0 Additional tax ($7,000) is less than $10,000, the minimum for C corporations c $0 Reported valuation ($50,000) is not at least 150% of correct value ($40,000) d $0 Reported valuation ($200,000) is not at least 150% of correct value ($150,000) e $35,000 additional tax × 20% penalty rate = $7,000 penalty assessed f $210,000 additional tax × 40% penalty rate = $84,000 penalty assessed (reported value is overstated by at least 200%) p 17-18 40 a $0 Additional tax ($1,750) is less than $5,000 b $0 Valuation claimed ($100,000) is not 65% or less than the correct value ($150,000) c $35,000 additional tax × 20% penalty rate = $7,000 penalty assessed d $122,500 additional tax × 40% penalty rate = $49,000 penalty assessed (reported value is 40% or less than the correct value) p 17-19 41 a Appraiser’s penalty under § 6695A = 10% × tax understatement (30% tax rate × $400,000 overstated deduction) = $12,000 b The penalty is limited to 125% of Singh’s appraisal fee = $6,250 p 17-20 42 a Section 6676 penalty for improper refund claim = 20% × disallowed deduction $400,000 = $80,000 b With a showing of the reasonable basis for the Eggers’ tax return position, the penalty now is zero p 17-20 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-18 43 2012 Corporations Volume/Solutions Manual Apply civil fraud penalty first Accuracy-related penalty due to negligence Total penalty due 75% × $10,000 = $ 7,500 20% × $110,000 = 22,000 $29,500 pp 17-17 and 17-20 44 a Current-Year Method First Quarter Payment [$45,000 tax ÷ payments × 90% required] Second Quarter Payment Third Quarter Payment Fourth Quarter Payment Prior-Year Method First Quarter Payment [($65,000 ÷ 4) × 110% required] Second Quarter Payment Third Quarter Payment Fourth Quarter Payment $10,125 10,125 10,125 10,125 $40,500 $17,875 17,875 17,875 17,875 $71,500 Thus, Trudy will use the current-year method for her estimates this year, as it produces the lower payment amount The remaining tax [$45,000 – $40,500 = $4,500] is due with the return, but no underpayment penalty is assessed b Because Trudy’s prior-year AGI did not exceed $150,000, the underpayment penalty is avoided if she remits only 100% of the prior-year tax Current-Year Method First Quarter Payment [$45,000 tax ÷ payments × 90% required] Second Quarter Payment Third Quarter Payment Fourth Quarter Payment Prior-Year Method First Quarter Payment [($20,000 ữ 4) ì 100% required] Second Quarter Payment Third Quarter Payment Fourth Quarter Payment $10,125 10,125 10,125 10,125 $40,500 $ 5,000 5,000 5,000 5,000 $20,000 Thus, Trudy now uses the prior-year method for her estimates this year, as it produces the lower payment amount The remaining tax ($45,000 – $20,000 = $25,000) is due with the return but no underpayment penalty is assessed pp 17-20 and 17-21 45 a First Quarter Payment [($170,000 tax ữ payments) ì 100% required] Second Quarter Payment Third Quarter Payment Fourth Quarter Payment Total estimates paid $ 42,500 42,500 42,500 42,500 $170,000 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Tax Practice and Ethics 17-19 Cannot use prior-year exception, which would have eliminated all estimated payments during the year; no positive tax on last year’s return b First Quarter Payment Second Quarter Payment Third Quarter Payment Fourth Quarter Payment Total estimates paid $ 38,250 38,250 38,250 38,250 $153,000 Use the prior-year exception Thus, each payment = 25% × $153,000 = $38,250 The remaining liability of $17,000 ($170,000 – $153,000 paid in installments) is due without penalty with the Form 1120 A Form 2220 should be attached to prove that no underpayment penalty is due c First Quarter Payment (25% × $136,000) Second Quarter Payment ($42,500 × = $85,000 due after quarters – $34,000 paid first quarter) Third Quarter Payment Fourth Quarter Payment Total estimates paid $ 34,000 51,000 42,500 42,500 $170,000 Kold is a ‘‘large corporation,” so it can use the prior-year exception only on its first quarter payment Underpayments from the first quarter are due with the next installment Thus, the basic payment = 25% × $170,000 = $42,500 pp 17-20 and 17-21 46 TAX FILE MEMORANDUM November 3, 2011 From: Stephanie Brewer Re: Scooter Company liabilities to IRS Scooter owes the original $100,000 in FICA and Federal income taxes, as redirected by Jeff, plus a 15% penalty for underdepositing of payroll taxes, under § 6656 If Scooter cannot or does not pay this amount, the IRS will assess a 100% penalty (again $100,000) against Jeff, the ‘‘responsible person’’ under § 6672, because Jeff’s failure to remit the withholdings was willful in intent Additional criminal penalties may be assessed, depending on the evidence surrounding Jeff’s actions Because this may involve jail time and even more monetary penalties, we must work to avoid this type of assessment by the IRS Because Scooter is now insolvent, the IRS may come after Jeff’s and Julie’s personal assets to satisfy these liabilities It likely does not matter that Julie appears not to have been involved in the underpayment scheme for this purpose She is a ‘‘responsible person’’ under the law as the board chair We must ascertain that the IRS does not assess more than the proper total that is due—because so many parties are involved, they may assess the entire amount due from the company and from its two shareholders This is improper, however, and we must monitor the IRS’s computations throughout this difficult time p 17-21 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-20 47 48 49 50 2012 Corporations Volume/Solutions Manual a The absence of a return precludes the running of the statute of limitations § 6501(c)(3) and p 17-23 b Although claims for refund normally are limited by the 3-year rule, seven years applies in the case of bad debts and worthless securities § 6511(d)(1) and p 17-24 c For a substantial omission (i.e., more than 25%) of gross income, a 6-year statute of limitations comes into play § 6501(e) and Example 15 d If the omission was deliberate, fraud probably is involved There is no statute of limitations on fraud § 6501(c)(1) and p 17-23 e The normal 3-year statute applies Unlike the substantial omission of income situation, the 6-year statute does not materialize p 17-23 a Suzanne must omit an amount of gross income which is in excess of 25% of the gross income stated on the return for the 6-year statute of limitations to apply Here, the omission must exceed $266,250 [($975,000 + $90,000) × 25%] When gross income for the period includes capital gains, such capital gains are not reduced by capital losses Example 15 b No This extended period of limitations rule has been interpreted to include only the omission of items affecting income, not the omission of items affecting cost of sales Footnote 52 c There is no statute of limitations on tax fraud § 6501(c)(1) and p 17-23 a Only $10,000 Because the refund claim was not filed within three years of the later of the due date or the actual filing of the return, Mark is limited to the amount he actually paid during the last two years (i.e., $10,000) § 6511(b)(2)(B) and Example 16 b Mark is not entitled to interest on the $10,000 unless the IRS failed to make the refund within 45 days of the amended-return filing date (May 18, 2011) If the refund is not made by July 2, 2011, interest accrues from the date of the now-discovered overpayment (June 1, 2010) through the refund payment date § 6611(e), Reg § 301.6611-1(j), pp 17-14 and 17-15 c The refund claim should have been filed by April 15, 2011, to allow a refund of the full $45,000 and interest thereon p 17-24 TAX FILE MEMORANDUM January 5, 2012 From: Eduardo Gomez Re: Carol’s refund claim Carol informed me that she attached a Post-It note to her Form 1040, with a brief explanation for why she reduced the amount due The reduction was attributable to an adjustment for a prior year The IRS certainly will ignore this informal “refund claim” and assess her the missing $1,000 in tax, plus interest and perhaps a penalty © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Tax Practice and Ethics 17-21 Carol failed to meet the compliance requirements for making a proper refund claim for the following reasons: • She did not use a Form 1040X for the adjustment year, restating the tax due to her inventory computation • She did not document the computations used to make her claim in sufficient detail p 17-24 51 Rod may represent himself for all years involved The same holds true for Cheryl, who is a CPA Ann may represent Rod only for tax year 2010 and only at the agent level Under Circular 230, only Rod and Cheryl may appear before the Appeals Division of the IRS Example 17 52 The § 6694 penalty does not depend on the amount of tax reduction that resulted from the disputed position The penalty is the greater of $1,000 or one-half of the fee charged for preparing the return Form 8275 disclosure is required to avoid the penalty if there is a reasonable basis for the disputed tax return position The penalty can be waived by showing reasonable cause for the position and that the preparer acted in good faith Form 8275 disclosure on the return of the disputed deduction? Tax reduction that resulted from the deduction ($) Probability that the deduction would be approved by the courts (%) Lois’ fee to complete the Yostern return ($) Amount of preparer penalty ($) a No 50,000 65 10,000 Substantial authority for the position b No 50,000 35 10,000 5,000 No substantial authority, no disclosure c No 50,000 35 1,500 1,000 No substantial authority, no disclosure d Yes 50,000 35 10,000 e Yes 50,000 15 5,000 No substantial authority, but disclosure was made 2,500 No reasonable basis pp 17-27 and 17-28 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-22 53 2012 Corporations Volume/Solutions Manual a The tax adviser is not subject to any return preparer penalties merely for suggesting to the client various means by which to acquire excludible income provided these means involve legal activities The tax adviser does not violate any disclosure requirements or rules governing improper conduct when he or she gives the client this information b The tax adviser could be charged with a criminal violation of the tax statutes This criminal penalty would be levied under § 7201 for attempting to evade or defeat the tax The adviser apparently could not be charged with some of the more common preparer penalties, such as willful understatement of liability, because the problem does not state that this tax adviser assisted in the preparation of a return [therefore, we cannot determine if the adviser is an income tax return preparer within the definition of § 7701(a)(36)] Moreover, the problem does not indicate whether the client followed the suggestions The tax adviser could be charged with a civil penalty under § 6701, because the scope of this statute is not limited to income tax preparers Therefore, if the tax adviser assists or advises with respect to the preparation or presentation of any portion of a return, affidavit, or other document in connection with any matter arising under the Internal Revenue laws, he or she is subject to the civil penalty provided in § 6701 for aiding and abetting a tax understatement c The tax adviser is subject to the civil income tax preparer penalties, since the return preparer rules apply to tax return preparers, including conduct with respect to excise, estate and gift, and employment tax returns The tax adviser also could be charged with a penalty for aiding and abetting an understatement of tax liability, which is a civil penalty under § 6701 In addition, the tax adviser presumably could be charged with a criminal penalty A person who willfully aids or assists in the preparation of a return or other document that is false as to any material matter is guilty of a violation of § 7206(2) d If any part of an understatement of liability with respect to an income tax return is due to a position for which there was not a more-likely-than-not possibility of being sustained on its merits, a tax return preparer who knows or should have known of such a position is subject to a § 6694 penalty Even if the facts suggest, though, that the return was prepared negligently, the penalty may be ignored if the preparer’s normal office practice, when considered together with other facts and circumstances, such as the technical tax knowledge of the preparer, indicates that the error would occur only rarely, and the normal office practice was followed in preparing the return It is likely that the tax adviser then would be charged with a negligence penalty, because the normal office practice was not followed with respect to this return The adviser could not be charged with either a criminal or civil fraud penalty, because the adviser did not exhibit the requisite intent to act in a deceptive or misleading manner e The penalty for understatements due to unreasonable positions would not apply, since the mathematical error was not the result of an unreasonable position being taken on the return It is unlikely that a taxpayer penalty would be assessed in this case, but the preparer is liable to the client for any interest and penalties the client incurs because of the preparer’s failure to exercise due care pp 17-27 and 17-28 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Tax Practice and Ethics 54 17-23 a 20 infractions × $50 penalty each = $1,000 total penalty under § 6695 b 25 infractions × $1,000 penalty each = $25,000 total penalty under § 6694(a) Repeated infractions over the years or other evidence might instead bring about a reckless conduct penalty of $5,000 per infraction under § 6694(b) c infractions × $10,000 penalty each = $50,000 total penalty under § 6701 The penalty is assessed on Gerry, not the intern This penalty is in lieu of both the unreasonable position and the willful and reckless conduct penalties pp 17-27 to 17-29 55 a False Audit probabilities not modify disclosure requirements b False The CPA should withdraw only if the client refuses to correct the error or if continuing in the engagement would compromise the client’s case c False Reasonable estimates are acceptable d True The error should not be disclosed to the IRS without the client’s consent e False Only if the error has a carryover effect so as to preclude the correct determination of the tax liability for the current year pp 17-30 to 17-33 The answers to the Research Problems are incorporated into the Instructor’s Guide with Lecture Notes to accompany the 2012 Annual Edition of SOUTH-WESTERN FEDERAL TAXATION: CORPORATIONS, PARTNERSHIPS, ESTATES & TRUSTS © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-24 2012 Corporations Volume/Solutions Manual NOTES © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part ... part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-24 2012 Corporations Volume/Solutions Manual NOTES © 2012 Cengage Learning All Rights Reserved... Instructor’s Guide with Lecture Notes to accompany the 2012 Annual Edition of SOUTH-WESTERN FEDERAL TAXATION: CORPORATIONS, PARTNERSHIPS, ESTATES & TRUSTS © 2012 Cengage Learning All Rights Reserved May...To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-2 Question/ Problem 2012 Corporations Volume/Solutions Manual Learning Objective *34 *35