1. The Tax Practice Environment
Chapter 2
The Tax Practice Environment

2. Tax Practice Tax compliance Tax planning 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

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. Cash Flows & Present Value
Cash flows in future years are discounted to their present value so they can be compared in today’s dollars
When marginal tax rates are expected to change from year to year, timing transactions accordingly will minimize tax costs and maximize tax savings

5. 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

6. 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%)

7. 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

8. 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

9. Primary Sources of Authority
Statutory
Administrative
Judicial

10. 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

11. 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

12. 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

13. 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 §)

14. Administrative Sources of Authority
Treasury Regulations
Internal
Revenue
Service
Revenue Rulings
Revenue Procedures
Letter Rulings
& other pronouncements

15. Judicial Sources U. S. Court of U. S. Court of Federal Claims
Appeals for
Federal Circuit
U. S.
District
Court
The
Supreme
Court
U. S. Court of
Appeals
U. S. Tax Court

16. 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

17. 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

18. Filing Penalties Failure-to-pay penalty Failure-to-file 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)

19. 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)

20. 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)

21. 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

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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

28. Collection Procedures
IRS sends bill to taxpayer
If no response, letter demanding payment in 10 days
IRS can impose lien on taxpayer’s property and seize assets
Offer in compromise
Innocent spouse relief

29. 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 preparer’s entire practice
Criminal tax evasion penalties include fines and prison

30. 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

31. Tax Research
Appendix 2A

32. 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

33. 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

34. 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

35. 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

36. 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 court’s statement of the reasons for its decision

37. 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

38. 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 decision’s history
What other courts have said about that case

39. 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?

40. Communicating Recommendations
Memo to the file usually contains:
Restatement of relevant facts
Issues addressed
Conclusions (researcher’s recommendations)
Discussion of reasoning and authorities
Client letter

41. The End