©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 12 Tax Administration and Tax Planning Tax Administration and Tax Planning

© 2003 South-Western College PublishingTransparency 12-2 Objective Be familiar with the organizational structure of the Internal Revenue Service

© 2003 South-Western College PublishingTransparency 12-3 Organization of IRS rCongress creates tax law and the IRS enforces it <Includes assessment and collection rIRS is a branch of the Department of the Treasury rCommissioner of IRS is appointed by President and approved by Congress

© 2003 South-Western College PublishingTransparency 12-4 Organization of IRS rHeadquartered in Washington DC rRegional Commissioners oversee four regional offices in Atlanta, Dallas, New York and San Francisco rDistrict offices are located throughout US and report to their respective regional offices rTen service centers are responsible for processing information

© 2003 South-Western College PublishingTransparency 12-5 IRS Restructuring Act of 1998 rDue to persistent problems with taxpayer service, this act sought to structurally & operationally change the IRS (thereby making it more accountable to the taxpayer) <Created separate National Taxpayer Advocate <Created independent Oversight Board <Mandated new taxpayer problem resolution procedures <Created new operating units to serve like kind taxpayers

© 2003 South-Western College PublishingTransparency 12-6 Objective Have a general understanding of the IRS audit process

© 2003 South-Western College PublishingTransparency 12-7 IRS Audits rIRS has right to examine taxpayers’ accounting records in a process called an audit <Correspondence audits occur via mail <Office audits occur at IRS office <Field audits occur at taxpayer’s business rTax returns are selected for audit based upon a multitude of factors such as: <High DIF (Discriminant Function System) score [designated because of items falling outside of normal parameters] <Randomly selected tax returns chosen through TCMP (Taxpayer Compliance Measurement Program) ÙThe TCMP has been suspended and the IRS is developing an alternative system to measure compliance

© 2003 South-Western College PublishingTransparency 12-8 Audit Appeals rThere are three possible results from an audit <Agent determines that there are no changes <Agent and taxpayer agree that there is a change in tax liability <Agent and taxpayer disagree on outcome rIn the last scenario, taxpayer may appeal through established appeals procedures <Appeal can move through Appeals Office, Tax Court, petitioning to the Regional Tax Court, Court of Appeals and ultimately the US Supreme Court

© 2003 South-Western College PublishingTransparency 12-9 Objective Know the common penalties for taxpayers and tax preparers and be able to calculate them

© 2003 South-Western College PublishingTransparency Interest rInterest is charged to taxpayer for late taxes (for example, prior year audit reveals tax due) rInterest is paid to the taxpayer for refund (prior year audit reveals refund due) rInterest received from IRS is income; interest paid to IRS by taxpayers is nondeductible consumer interest rInterest rate is set at 3 points above the short term federal rate and is adjusted quarterly

© 2003 South-Western College PublishingTransparency Failure to File Penalties rIf a tax return is not filed by its due date (with extensions) <Penalty of 5% of tax is due per month (or 15% if fraudulently failing to file) <Limited to 25% in total (or 75% if fraudulent) rMinimum penalty if return is filed within 60 days of due date (with extensions) <Lesser of $100, or <Tax due rThis penalty is reduced by failure to pay penalty, if both penalties apply

© 2003 South-Western College PublishingTransparency Other Penalties rFailure to Pay Penalty <Penalty is 0.5% of tax for each month tax is late <Limited to 25% in total rAccuracy Related Penalty <If calculations on tax return substantially understate income or overstate expenses, IRS can impose a 20% underpayment penalty (based upon tax due) for willful disregard of tax law <If the IRS can prove with a ‘preponderance of evidence’ that a taxpayer purposefully evaded tax by committing fraud, they can impose a 75% fraud penalty on the amount of taxes due

© 2003 South-Western College PublishingTransparency Other Penalties (continued) rPenalty for failing to file informational returns on a timely basis (1099s, W-2s, etc) rPenalty for filing a frivolous tax return rPenalty for filing false withholding information rPenalty for writing a bad check for taxes rPenalty for underpaying estimated taxes

© 2003 South-Western College PublishingTransparency Objective Know the general rule for the statute of limitations on tax returns

© 2003 South-Western College PublishingTransparency Statute of Limitations rA taxpayer may not amend, nor may the IRS assess additional taxes, on a tax return for which the statute of limitations has expired <Generally this is 3 years from due date <Becomes 6 years if amount of gross income omitted exceeds 25% of gross total <No limit if tax return was fraudulently filed rIf IRS and taxpayer agree, Form 872 may be signed that allows for extension of statute of limitations

© 2003 South-Western College PublishingTransparency Tax Preparers rAny person compensated for preparing another person’s tax return is “paid tax return preparer” rOnly CPAs, attorneys or enrolled agents may represent clients at IRS proceedings rThere are a multitude of penalties if preparer does not conduct business with due diligence, sign returns, provide copy to clients, etc. rThe attorney-client privilege has been extended in limited circumstances to non-attorneys who are authorized to practice in front of the IRS (i.e., CPAs and enrolled agents)

© 2003 South-Western College PublishingTransparency Objective Be familiar with the process of filing tax returns electronically

© 2003 South-Western College PublishingTransparency e-Filing rElectronic filing is a process of transmitting tax returns by an ERO (electronic return originator) directly to IRS rForm 8453 (US Individual Income Tax Declaration for Electronic Filing), with original signatures and forms that cannot be electronically transmitted, must also be mailed rTax preparers may only transmit 5 returns without officially requesting approval to be part of electronic filing system via Form 8633

© 2003 South-Western College PublishingTransparency Refund Anticipation Loans rTaxpayer can arrange a refund anticipation loan (RAL) at many places that transmit electronic returns <If refund is requested in form of direct deposit, may take days <IRS makes no guarantee that refund will not be applied against debt to government, such as defaulted student loans or other tax liens

© 2003 South-Western College PublishingTransparency Taxpayer Bill of Rights rDocument addresses taxpayers rights rRequires the IRS to inform taxpayers of their rights when dealing with the Service <It provides remedies for resolving disputes with the IRS rPart I – Declaration of Taxpayer Rights rPart II –Examinations, Appeals, Collections & Refunds

© 2003 South-Western College PublishingTransparency Objective Know the basic concepts of tax planning

© 2003 South-Western College PublishingTransparency Tax Planning rAverage tax rate equals total tax paid divided by total income rMarginal tax rate is the tax rate on the “next” dollar of income <The relevant tax rate for tax planning rTax avoidance (planning) refers to the taxpayer arranging his/her affairs in such a way that financial transactions produce the most favorable tax treatment allowed by law

© 2003 South-Western College PublishingTransparency Tax Planning (continued) rTax evasion refers to the taxpayer avoiding tax in a manner that is illegal and can result in penalties and/or incarceration rGood planning helps the taxpayer avoid “tax traps” <Areas in the law that will result in a loss of benefit if a transaction is not well formed

© 2003 South-Western College PublishingTransparency Finished!