Chapter 17.docx

Chapter 17

True/FalseIndicate whether the statement is true or false.

____ 1. The tax professional can do more than just tax compliance work. He or she can work with the client in consultation over the strategy and tactics of dealing with a Federal tax audit.

____ 2. The IRS employs almost 90,000 personnel, making it one of the largest Federal agencies.

____ 3. Recently, the overall Federal income tax audit rate for individual returns has been about 3%.

____ 4. The IRS targets high-income individuals for an audit rate that is about double that of the general populace.

____ 5. IRS computers use document matching programs for both individuals and business taxpayers to keep the audit rate low.

____ 6. The “IRS’ attorney” is known as the Chief Counsel.

____ 7. One of the four operating divisions of the IRS deals exclusively with manufacturing and exporting businesses.

____ 8. In a letter ruling, the IRS responds to a taxpayer request concerning the tax treatment of a proposed transaction.

____ 9. An IRS letter ruling might determine that an employee’s compensation is unreasonable in amount.

____ 10. A letter ruling is issued by the IRS at no charge.

____ 11. The IRS can require that the taxpayer produce its financial accounting records, to determine if taxable income is computed correctly.

____ 12. When a tax issue is taken to court, the burden of proof is on the taxpayer to show that the items reported on the return are correct.

____ 13. When the IRS issues a notice of tax due, the taxpayer has 30 days to either pay the tax or file a petition with the Tax Court. This is conveyed in the “thirty-day letter.”

____ 14. An “office audit” takes place at the headquarters office of the corporate taxpayer.

____ 15. After a tax audit, the taxpayer receives the Revenue Agent’s Report as part of the “90-day letter.”

____ 16. Neither the taxpayer nor the government can appeal a decision of the Tax Court Small Cases Division.

____ 17. Babs filed an amended return in 2011, claiming a refund relative to her 2009 tax computation. When the IRS approves the amended return, it will pay Babs interest with respect to the overpayment.

____ 18. During any month in which both the failure-to-file and failure-to-pay penalties apply, both penalties must be paid in full.

____ 19. Maria and Miguel Blanco are in the midst of negotiating a divorce. Because both parties are unwilling to share any current financial information, their joint Form 1040 for 2011 is not filed until October 31, 2012, when the respective divorce attorneys forced them to cooperate. The Blancos should not be subject to any Federal late-filing penalties, because of the reasonable cause exception.

____ 20. A negligence penalty is 20% of the underpayment attributable to negligence.

____ 21. Jaime’s negligence penalty will be waived, under the reasonable cause exception. He told the court, “My taxes were wrong because I couldn’t understand the tax law.”

____ 22. Because he undervalued property that he transferred by gift, Dan owes additional gift taxes of $8,000. The penalty for undervaluation does not apply in this situation, because the tax understatement was too small.

____ 23. In the context of civil tax fraud, the burden of proof is on the IRS to show by a “preponderance of the evidence” that the taxpayer had a specific intent to evade a tax.

____ 24. In a criminal fraud case, the burden is on the taxpayer to show that he or she was innocent “beyond the shadow of any reasonable doubt.”

____ 25. Yang, a calendar year taxpayer, did not file a tax return for 2005 because she honestly believed that no additional tax was due. In 2011, Yang is audited by the IRS and the agent assesses a deficiency of $17,000 for tax year 2005. Yang need not pay this deficiency, since the statute of limitations expired on April 15, 2009.

____ 26. Keepert uses “two sets of books.” She only reports one-half of her cash sales on the records that she uses to complete her Federal income tax return. The statute of limitations for Keepert’s return is six years.

____ 27. In the case of bad debts and worthless securities, the statute of limitations on claims for refund is seven years.

____ 28. Jenny prepared Steve’s income tax returns for no compensation for 2008 and 2009. Jenny is Steve’s mother. In 2011, the IRS notifies Steve that it will audit his returns for 2007-2009. If Steve so desires, Jenny may represent him during the audit of all three returns.

____ 29. Circular 230 applies to all tax practitioners. This includes attorneys, CPAs, and enrolled agents, even though each of the groups has its own code of conduct.

____ 30. Circular 230 requires that a tax preparer be aware of changes in the tax law. Furthermore, office practices of the preparer must be up to industry standards.

____ 31. Under Circular 230, Burke cannot complete a client’s original Form 1040 and charge a fee equal to one-third of the resulting refund.

____ 32. As part of a tax return engagement for XYZ Partnership, Enrolled Agent Wang can draft an amendment to the XYZ partnership agreement.

____ 33. Circular 230 prohibits a tax preparer from charging an unconscionable fee for his/her services.

____ 34. A tax preparer cannot disclose to a mortgage banker the client’s income level, or other information acquired by preparing the return, without the client’s permission.

____ 35. A VITA volunteer is exempted from the Code’s tax preparer penalties.

____ 36. Latrelle prepares the tax return for Whitehall Corporation. Latrelle includes a $5,000 deduction on the return. This type of deduction previously has been disallowed by the Tax Court, although there is a 15% chance that the holding will be reversed on an appeal. The return does not make any special disclosure that the deduction is being claimed. Whitehall paid Latrelle a fee of $3,000 for preparing the Form 1120. Latrelle will be assessed a preparer penalty of $1,000 for taking an unreasonable position on the Whitehall return.

____ 37. A CPA and his/her client hold a privilege of confidentiality from the IRS, as to their discussions about completing a tax return.

____ 38. The Statements on Standards for Tax Services apply to members of the AICPA.

____ 39. The AICPA’s Statements on Standards for Tax Services must be followed its members; they are more than merely advisory.

____ 40. A CPA can take a tax return position for a client that is contrary to current IRS interpretations of the law.

____ 41. Faye, a CPA, is preparing Judith’s tax return. Before computing Judith’s deduction for business supplies, Faye must examine Judith’s records in support of the deducted amount.

____ 42. In preparing a tax return, a CPA should verify “to the penny” every item of information submitted by a client.

____ 43. Last year, Ned’s property tax deduction on his residence was $22,500. Although he lives in the same house, he tells his CPA that this year’s taxes will be only $7,500. The CPA can use this estimate in computing Ned’s itemized deductions, under the Statements of Standards for Tax Services.

____ 44. Henrietta has hired Gracie, a CPA, to complete this year’s Form 1040. Henrietta uses software to keep the books for her business. She tells Gracie that a $5,000 amount for business supplies is “close enough” to constitute the deduction. Gracie can use this estimate in completing the Form 1040.

____ 45. When a practitioner discovers an error in a client’s prior return, AICPA tax ethics rules require that an amended return immediately be filed.

____ 46. It is advisable that an IRS audit be conducted at the office of the tax advisor, and not of the client.

____ 47. When a “prompt assessment” of the tax liability is requested, the taxpayer essentially is volunteering for an IRS audit of the tax return.

Multiple ChoiceIdentify the choice that best completes the statement or answers the question.

____ 1. The Chief Counsel of the IRS is appointed by the:a. Secretary of the Treasury Department.b. U. S. Senate. c. U. S. House of Representatives.d. U. S. President. e. American Bar Association President.

____ 2. Which statement appearing below does not correctly describe the IRS letter ruling process?a. They are issued by the Secretary of the Treasury Department.b. Some letter rulings are of such importance and general interest that they are later

published (in anonymous form) as Revenue Rulings.c. Letter rulings are private and can be seen only by the taxpayer who requested the ruling. d. Letter rulings can benefit both taxpayers and the IRS.

____ 3. Which of the following statements is incorrect as to the conduct of IRS income tax audits?a. Only the Appeals Division of the IRS has the authority to settle tax disputes based on the

hazards of litigation.b. The IRS publishes the factors its computers use for audit selection purposes annually in

the Commissioner’s Report.c. For a Form 1040 that is filed on April 11, 2012, if the taxpayer has not received an audit

notification from the IRS by the end of 2012, the return may still be audited.d. Most IRS examinations of Forms 1040 are conducted solely through the mail.

____ 4. Which of the following statements is correct as to the conduct of IRS income tax audits?a. Office audits are conducted at the office of the IRS.b. The most common type of Federal income tax audit is the field audit.c. An office audit typically is used for a business taxpayer.d. A correspondence audit usually is concluded after a meeting with the taxpayer at the IRS

auditor’s office.

____ 5. With respect to the Small Cases Division of the Tax Court,a. The taxpayer (but not the IRS) can appeal a contrary judgment.b. The IRS (but not the taxpayer) can appeal a contrary judgment.c. Either the IRS or the taxpayer can appeal a contrary judgment.d. Neither the IRS nor the taxpayer can appeal a contrary judgment.

____ 6. Which of the following statements correctly reflects the rules governing interest to be paid on an individual’s Federal tax deficiency or claim for refund?a. The IRS has full discretion in determining the rate that will apply.b. The simple interest method for calculating interest is used.c. The rate of interest for assessments is one percentage point lower than the rate of interest

for refunds.d. The IRS adjusts the rate of interest quarterly.

____ 7. Which of the following statements does not reflect the rules governing the accuracy-related penalty for negligence?a. The penalty rate is 20%.b. The penalty is imposed only on the part of the deficiency attributable to negligence.c. The penalty applies only to intentional tax understatements by the taxpayer.d. The penalty is waived if the taxpayer uses Form 8275 to disclose a return position that is

reasonable though contrary to the IRS position.

____ 8. The penalty for substantial understatement of tax liability does not apply if:a. The taxpayer has substantial authority for the treatment taken on the tax return.b. The relevant facts affecting the treatment are adequately disclosed in the return or on Form

8275.c. The IRS failed to meet its burden of proof in showing the taxpayer’s error.d. All of the above statements are correct.e. None of the above statements are correct.

____ 9. Ming (a calendar year taxpayer) donates a painting to a local art museum (a qualified charity). The painting cost Ming $2,000 ten years ago and, according to one of Ming’s friends (an amateur artist), is worth $40,000. On his income tax return, Ming deducts $40,000 as a Form 1040 charitable contribution. Upon later audit by the IRS, it is determined that the true value of the painting was $30,000. Assuming that Ming is subject to a 30% marginal Federal income tax rate, his penalty for overvaluation is:a. $5,000. b. $2,000. c. $1,000.d. $0.e. $10,000 (minimum penalty).

____ 10. Harold, a calendar year taxpayer subject to a 35% marginal tax rate, claimed a Form 1040 charitable contribution deduction of $20,000 for a sculpture that the IRS later valued at $10,000. The applicable overvaluation penalty is:a. $10,000.b. $7,000. c. $3,500.d. $0.

____ 11. Maureen, a calendar year taxpayer subject to a 35% marginal tax rate, claimed a Form 1040 charitable contribution deduction of $250,000 for a sculpture that the IRS later valued at $200,000. The applicable overvaluation penalty is:a. $17,500.b. $14,000.c. $3,500.d. $0.

____ 12. Ron, a calendar year taxpayer subject to a 35% marginal tax rate, claimed a Form 1040 charitable contribution deduction of $250,000 for a sculpture that the IRS later valued at $150,000. The applicable overvaluation penalty is:a. $0. b. $7,000. c. $10,000 (maximum penalty).d. $14,000.

____ 13. Gloria, a calendar year taxpayer subject to a 35% marginal income tax rate, claimed a Form 1040 charitable contribution deduction of $800,000 for a sculpture that the IRS later valued at $100,000. The applicable overvaluation penalty is:a. $245,000.b. $98,000.c. $49,000.d. $10,000 (maximum penalty).

____ 14. George, a calendar year taxpayer subject to a 45% marginal gift tax rate, made a gift of a sculpture to Redd, valuing the property at $100,000. The IRS later valued the gift at $140,000. The applicable undervaluation penalty is:a. $7,200. b. $3,600. c. $1,000 (minimum penalty).d. $0.

____ 15. Leroy, who is subject to a 45% marginal gift tax rate, made a gift of a sculpture to Marvin, valuing the property at $150,000. The IRS later valued the gift at $400,000. The applicable undervaluation penalty is:a. $0.b. $22,500. c. $25,000 (maximum penalty).d. $45,000.

____ 16. Juanita, who is subject to a 45% marginal gift tax rate, made a gift of a sculpture to Bianca, valuing the property at $150,000. The IRS later valued the gift at $300,000. The applicable undervaluation penalty is:a. $27,000.b. $13,500.c. $10,000 (maximum penalty). d. $0.

____ 17. The special tax penalty imposed on appraisers:a. Is waived if the taxpayer also was charged with his/her own valuation penalty.b. Applies if the appraiser knew that the appraisal would be used in preparing a Federal

income tax return.c. Equals 10% of the appraised value of the property, with a $5,000 minimum penalty.d. Can be as much as 200% of the appraisal fee that was charged.

____ 18. Concerning the penalty for civil tax fraud:a. Fraudulent behavior is more than mere negligence on the part of the taxpayer. b. The burden of proof to establish the penalty is on the government.c. The penalty is 100% of the underpayment.d. Fraud is defined in Code §§ 6663(b) and (f).

____ 19. Concerning a taxpayer’s requirement to make quarterly estimated tax payments:a. An individual must make estimated payments if his or her balance due for the Federal

income tax for the year will exceed $1,000. b. The due dates of the payments for a calendar-year C corporation are March, June,

September, and December 15.c. A C corporation must make estimated payments if its Federal income tax liability for the

year will exceed $250.d. A trust is not required to make estimated payments.

____ 20. Mickey, a calendar year taxpayer, was not required to file a 2010 Federal income tax return. During 2011, his AGI is $120,000 and his tax liability is $20,000. To avoid a penalty for tax underpayments for 2011, Mickey must make aggregate estimated tax payments of at least:a. $0.b. $1,000 (minimum amount).c. $18,000.d. $20,000.

____ 21. Mickey, a calendar year taxpayer, filed a return correctly showing no Federal income tax liability for 2010. During 2011, his AGI is $120,000 and his tax liability is $20,000. To avoid a penalty for 2011, Mickey must make aggregate estimated tax payments of at least:a. $0.b. $1,000 (minimum amount).c. $18,000.d. $20,000.

____ 22. The usual three-year statute of limitations on additional tax assessments applies in the following situation(s).

a. No return at all is filed.b. An investment in a marketable security is worthless.c. Taxpayer inadvertently omits an amount of gross income equal to 30% of the gross

income stated on the return.d. Taxpayer discovers an inadvertent overstatement of deductions equal to 30% of gross

income.

____ 23. Jake, an individual calendar year taxpayer, incurred the following transactions.

Gross receipts $800,000 Less: Cost of sales (300,000)Net business income $500,000 Capital gain $30,000 Capital loss (90,000) (60,000)Total income $440,000

Assuming that any error in timely reporting these amounts was inadvertent, how much omission from gross income would be required before the six-year statute of limitations would apply?a. More than $110,000. b. More than $132,500. c. More than $207,500. d. The six-year rule does not apply here.

____ 24. Vera is audited by the IRS for several tax years. Her returns were prepared by the following parties.

Tax Year Preparer1 Sally (Vera’s niece, a dentist)2 Wesley (pastor of Vera’s church)3 Alex (a CPA)

Which of the following statements is correct?a. Sally may represent Vera for tax year 1. Such representation may extend through the

Appeals Division of the IRS.b. Wesley may represent Vera for all tax years under audit.c. Alex can only represent Vera for tax year 3.d. Vera may represent herself for all tax years involved.

____ 25. The rules of Circular 230 need not be followed by which of the following paid tax preparers?a. A CPA.b. A Wal-Mart cashier who e-files 15 tax returns for her paying clients per filing season.c. An enrolled agent.d. All of the above are subject to the Circular 230 rules.

____ 26. Circular 230 allows a tax preparer to:a. Take a position on a tax return that is contrary to a decision of the U.S. Supreme Court.b. Operate the “Tax Nerd’s Blog” on the Internet.c. Charge a $5,000 fee to prepare a Form 1040EZ. d. Avoid signing a tax return that is likely to be audited.

____ 27. A tax preparer is in violation of Circular 230 if he or she:a. Files a tax return that includes a math error.b. Charges a fee to prepare an original Form 1120 equal to one-third of the taxpayer’s refund

due.c. Fails to inform the IRS of an error on the client’s prior-year return.d. All of the above are Circular 230 violations.

____ 28. Which of the following is subject to tax return preparer penalties?a. Lizzie, the firm’s administrative assistant, makes copies of returns and assembles the

mailings that the client must make to the taxing agencies.b. Meredith is the director of Federal taxes for a C corporation.c. Sammy is a volunteer who prepares returns at the retirement home under the IRS Tax

Counseling for the Elderly program.d. Abbie prepares her mother’s tax returns for $50 a year. A CPA, Abbie would charge a

client $750 for completing a similar return.

____ 29. Megan prepared for compensation a Federal income tax return for Joan. Joan’s return included an aggressive interpretation of the rules concerning overnight business travel. Megan is not liable for a preparer penalty for taking an unreasonable tax return position if:a. The tax reduction attributable to the disputed deduction did not exceed $5,000. b. There was a reasonable basis for Joan’s interpretation of the travel deduction rules.c. There was substantial authority for Joan’s interpretation of the travel deduction rules.d. The IRS found that the travel deduction was frivolous, but Joan disclosed the position in

an attachment to the return.

____ 30. Roger prepared for compensation a Federal income tax return for Mona. Mona’s return included an aggressive interpretation of the rules concerning overnight business travel. Roger is not liable for a preparer penalty for taking an unreasonable tax return position if:a. The tax reduction attributable to the disputed deduction did not exceed $5,000. b. Mona is assessed her own penalty for an understatement of tax due to disregard of IRS

rules. c. There was a reasonable basis for Mona’s interpretation of the travel deduction rules, and

Mona disclosed the position in an attachment to the return.d. The IRS found that the travel deduction was frivolous, but Mona disclosed the position in

an attachment to the return.

____ 31. Freddie has been assessed a preparer penalty for willful and reckless conduct. When he completed Peggy’s Federal income tax return (who is in the 35% tax bracket), Freddie purposely omitted $100,000 of cash receipts that should have been reported as gross income. Freddie charged Peggy $6,000 to prepare the return. What is Freddie’s preparer penalty?a. $0, because Peggy incurred her own understatement penalty for the return.b. $3,000.c. $5,000.d. $17,500.

____ 32. The privilege of confidentiality applies to a CPA tax preparer concerning the client’s information relative to:a. Financial accounting tax accrual workpapers.b. A tax research memo used to determine an amount reported on the tax return.c. Building a defense against a penalty assessed for the use of a tax shelter.d. Building a defense against a charge brought by the SEC.

____ 33. The Statements on Standards for Tax Services are issued by the:a. IRS.b. AICPA.c. ABA.

d. SEC.

Matching

Match each of the following penalties with the rate for that penalty as specified by the Code.a. $50 per violationb. $500 per violationc. $1,000 per violationd. 1/2% per month, maximum 25%e. 5% per month, maximum 25%f. 15% per month, maximum 75%g. 75% of tax dueh. 20% of tax duei. 15% of tax duej. 10% of tax due

____ 1. Failure to file a tax return

____ 2. Fraudulent failure to file a tax return

____ 3. Failure to pay a tax

____ 4. Negligence

____ 5. Improper refund claim

____ 6. Misstatement of withholding allowances

____ 7. Civil tax fraud

____ 8. Failure to pay over a withheld tax

____ 9. Substantial understatement of a tax

____ 10. Failure by a tax preparer to sign the return

For each of the indicated penalties, indicate the appropriate taxpayer defense.a. Reasonable basisb. Reasonable causec. Substantial authorityd. Disclosure on return

____ 11. Negligence in filing a return

____ 12. Substantial understatement of tax liability

____ 13. Failure to pay a tax that is due

____ 14. Undervaluation of a reported item

____ 15. Filing an improper refund claim

____ 16. Failure to deposit withholding tax

____ 17. Preparer penalty for taking an unreasonable tax return position

____ 18. Preparer penalty for reckless conduct

CompletionComplete each statement.

1. The IRS is a subsidiary agency of the Department of the ____________________.

2. About ____________________% of all Forms 1040 are audited each year. The rate is about ____________________% if income exceeds $1 million.

3. The IRS is one of the largest Federal agencies, employing at least ____________________ people throughout the year.

4. According to the IRS, the annual “Tax Gap” totals about $______________________ billion.

5. The IRS processes about ____________________ million individual tax returns every year.

6. The chief executive of the IRS is the _________________________.

7. The ____________________, a presidential appointee, is the “IRS attorney.”

8. A(n) ____________________ should be requested when the taxpayer wants to know the IRS interpretation of how the tax law will be applied to a proposed transaction.

9. The taxpayer might secure a(n) ____________________ to assure that a homeless shelter qualifies for tax exempt treatment.

10. During an audit, the IRS might require that the taxpayer produce the ____________________ that underlie the tax return data ..

11. After the completion of an audit, the taxpayer has ____________________ days to petition the Tax Court to modify the proposed tax due.

12. If the taxpayer refuses to pay an assessed tax, the IRS can seize taxpayer property under the ____________________ process.

13. The IRS can pay an informant’s fee of up to ____________________% of the recovered tax, interest, and penalty amounts. In the typical year, about ____________________ such rewards are paid. The reward can be as high as ____________________% for information provided by a “whistle blower.”

14. A taxpayer’s return might be selected for audit on the basis of the ____________________ score that the IRS computes.

15. If the auditor comes to the taxpayer’s office to review a tax return, the review is called a(n) ____________________ audit.

16. In taking a dispute to the Appeals Division, a written protest is required of the taxpayer when the proposed deficiency exceeds $____________________.

17. A taxpayer can take a dispute to the Small Cases Division of the Tax Court when the disputed amounts do not exceed $____________________.

18. The taxpayer can use a(n) ____________________ to pay off a deficiency over a longer period of time, if the IRS believes that this will facilitate the tax collection process.

19. The IRS pays interest on a refund to the taxpayer, unless the IRS’s payment is made within ____________________ days of the date that a return is filed.

20. A taxpayer can be subject to both ____________________ and ____________________ penalties for tax misconduct.

21. If the taxpayer shows ____________________ for an underpayment of tax, the failure to pay penalty can be reduced or eliminated.

22. The accuracy-related penalties typically relate to ____________________on the part of the taxpayer, or other understatements of tax.

23. A negligence penalty can be waived if the taxpayer has used Form 8275 to ____________________ a tax return position that is contrary to a judicial precedent.

24. The IRS can waive the penalty for understating a tax liability if the taxpayer shows ____________________ for the position taken on the tax return.

25. A ____________________% penalty may result when a taxpayer overstates by _____________________ percent or more the value of an asset contributed to a charity.

26. The taxpayer can avoid a valuation penalty for overstating the value of the charitable contribution of an artwork by showing that the deduction claimed was based on a qualified ____________________.

27. A penalty can be assessed from an appraiser who knew that his/her improper appraisal would be used as part of a tax computation, in the amount of the lesser of ____________________% of the tax understatement or ____________________ % of the appraisal fee collected.

28. Quon filed an amended return, claiming a $100,000 refund. The IRS disallowed the refund, and it can assess a penalty if there was no reasonable basis of support for the refund claim, in the amount of ____________________% of the disallowed amount.

29. A C corporation is not subject to an underpayment penalty until more than $____________________ is due and unpaid through estimated taxes.

30. Maria’s AGI last year was $195,000. To avoid a penalty, her estimated tax payments and withholdings for this year must equal the lesser of ____________________ percent of last year’s taxes or ____________________ percent of this year’s taxes.

31. The general statute of limitations regarding Federal tax returns extends for ____________________ years. It is ____________________ years if a substantial understatement of income is found, and ____________________ years with respect to worthless securities.

32. To file for a tax refund, an individual generally uses Form ____________________.

33. A CPA, an attorney, and a(n) ____________________ can represent taxpayers before the IRS.

34. The basic Treasury document regulating tax preparers is the Regulation known as _________________________.

35. A tax preparer can incur a penalty if the client’s return includes an unreasonable or ___________________ tax return position that understates the tax liability.

36. For purposes of tax penalties, A VITA volunteer is not classified as a tax ____________________.

37. The tax preparer penalty for taking an unreasonable tax return position is the greater of $1,000 or ____________________ of the tax professional’s income from preparing the return.

38. A(n) $____________________ penalty applies if the tax preparer does not sign the client’s tax return.

39. The Code’s scope of privileged communications for a CPA extends only to ____________________ advice given.

40. According to AICPA rules, the CPA cannot take an aggressive tax return position on the basis of the “audit ____________________.”

41. A(n) ___________________ member is required to follow the Statements of Standards for Tax Services in conducting a tax practice.

Problem

1. Margaurite did not pay her Federal income tax on time. When she eventually filed the return, she reported a balance due. Compute Margaurite’s failure to file penalty in each of the following cases.

a. Two months late, $500 additional tax due.

b. Three months late, $2,000 additional tax due.

c. Ten months late, $10,000 additional tax due.

d. Three months late due to fraud by Margaurite, $10,000 additional tax due.

e. Fifteen months late due to fraud by Margaurite, $10,000 additional tax due.

2. Isaiah filed his Federal income tax return on time, but he did not remit the full balance due. Compute Isaiah’s failure to pay penalty in each of the following cases. The IRS has not yet issued a deficiency notice.

a. Two months late, $5,000 additional tax due.

b. Ten months late, $5,000 additional tax due.

c. Five years late, $5,000 additional tax due.

3. Compute the failure to pay and failure to file penalties for John, who filed his 2010 income tax return on December 14, 2011, paying the $10,000 amount due. On April 1, 2011, John submitted a six-month extension of time in which to file his return; he paid no tax with the extension request. He has no reasonable cause for failing to file his return by October 15 or for failing to pay the tax that was due on April 15, 2011. John’s failure to comply with the tax laws was not fraudulent.

4. Marco, a cash basis, calendar year taxpayer, filed his income tax return 50 days after the due date. Marco never extended his return, and with the return he paid the taxes that were due. What penalties will Marco incur, and how much is the penalty if his additional tax is $5,000? Disregard any additional interest he must pay.

5. Bettie, a calendar year individual taxpayer, files her 2009 return on February 10, 2011. She had obtained a six-month extension for filing her return. There was additional income tax of $20,000 due with the return.

a. What are Bettie’s penalties for failure to file and to pay?

b. Would your answer to a. change if Bettie, before the due date of the return, had retained a CPA to prepare the return and it was the CPA’s negligence that caused the delay?

6. Clara underpaid her taxes by $50,000. Of this amount, $15,000 was due to negligence on her part, as her record-keeping system is highly inadequate. Determine the amount of any negligence penalty

7. Leo underpaid his taxes by $250,000. Portions of the underpayment were attributable to negligence ($90,000) and to civil fraud ($160,000). Compute the total penalties incurred.

8. Compute the overvaluation penalty for each of the following independent cases involving the taxpayer’s reporting of the fair market value of charitable contribution property. In each case, assume a marginal income tax rate of 35%.

Taxpayer Corrected IRS Value Reported Valuea. Individual $ 10,000 $ 20,000 b. C corporation 10,000 30,000c. S corporation 10,000 30,000d. Individual 100,000 175,000e. Individual 100,000 250,000f. C corporation 100,000 500,000

9. Compute the undervaluation penalty for each of the following independent cases involving the executor’s reporting of the value of a closely held business in the decedent’s gross estate. In each case, assume a marginal estate tax rate of 45%.

Reported Value Corrected IRS Valuea. $10,000 $ 20,000 b. 60,000 100,000c. 80,000 150,000d. 50,000 300,000

10. Arnold made a charitable contribution of property that he valued at $70,000. He deducted this amount as an itemized deduction on his tax return. The IRS can show that the actual value of the property is $50,000. Arnold is in the 35% income tax bracket. Determine Arnold’s amount due for both tax and any penalty.

11. Carrie’s AGI last year was $180,000. Her Federal income tax came to $60,000, which she paid through a combination of withholding and estimated payments. This year, her AGI will be $250,000, with a projected tax liability of $80,000, all to be paid through estimates. Ignore the annualized income method. Compute Carrie’s quarterly estimated payment schedule for this year.

12. The Square Services Corporation estimates that its 2011 taxable income will be $1,000,000. Thus, it is subject to a flat 34% income tax rate and incurs a $340,000 liability. For each of the following independent cases, compute Square’s minimum quarterly estimated tax payments that will avoid an underpayment penalty.

a. For 2010, taxable income was ($200,000). Square carried back all of this loss to prior years and exhausted the entire net operating loss in creating a zero 2010 liability.

b. For 2010, taxable income was $700,000, and tax liability was $238,000.

c. For 2009, taxable income was $2 million, and tax liability was $680,000. For 2010, taxable income was $100,000, and tax liability was $22,250.

13. Troy Center Ltd. withheld from its employees’ paychecks $200,000 in Federal income and Social Security taxes for the Monday, June 30 payroll. It then spent the $200,000 on equipment upgrades, missing altogether the August 2 due date for the tax remittances. How much does Troy now owe the government in taxes and penalties? Ignore interest accruals, and assume that the Treasury can prove that Troy’s redirecting of the tax withholdings was willful.

14. Loren Ltd., a calendar year taxpayer, had the following transactions, all of which were properly reported on a timely filed return. Presuming the absence of fraud, how much of an omission from gross income must occur for Loren before the six-year statute of limitations applies? Show your computations.

Gross receipts $3,500,000 Cost of sales (1,000,000)Gross profit $2,500,000 Capital gain $100,000 Capital loss (30,000) 70,000 Total income $2,570,000

15. Yin-Li is the preparer of the Form 1120 for Cloves Corporation. On the return, Cloves claimed a deduction that the IRS later disallowed on audit. Compute the tax preparer penalty that could be assessed against Yin-Li in each of the following independent situations.

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 (%)

Yin-Li’s fee to complete the Cloves

return ($)

a. No 40,000 75 10,000b. No 50,000 30 800c. No 60,000 30 5,000d. Yes 70,000 30 5,000

e. Yes 80,000 10 5,000

Essay

1. A tax professional needs to know how the IRS is structured and how it works to carry out its mission. Evaluate this statement.

2. What are the chief responsibilities of the IRS Commissioner, and of the Chief Counsel of the IRS?

3. The IRS periodically updates its list of “audit initiatives,” the areas of tax enforcement that will receive special attention during the current tax year. List five or more of the current IRS audit initiatives.

4. The Treasury issues “private letter rulings” and other determinations, usually in response to a taxpayer request. What is the purpose of the rulings program? Answer from both the taxpayer and the government points of view.

5. Describe the following written determinations that are issued by the IRS.

a. Determination letter.

b. Technical advice memorandum.

c. Technical expedited advice memorandum.

6. Certain individuals are more likely than others to have the Form 1040 audited by the IRS. List at least five factors that may increase above the national norms one’s chances of audit.

7. Congress has set very high goals as to the number of Forms 1040 that should be filed electronically. Summarize the benefits of e-filing, from the perspective of both the taxpayer and the government.

8. If a taxpayer is audited by the IRS and is unwilling to accept the findings of the agent, how does the taxpayer’s audit strategy change when the dispute is taken to the IRS Appeals Division? Hint: What are the “hazards of litigation?”

9. When a tax dispute is resolved, interest is paid by or to the government. List three or more features of the interest computations that arise when a tax return is audited.

10. In connection with the taxpayer penalty for substantial understatement of tax liability, what defenses (if any) are available?

11. A taxpayer penalty may be waived if there is shown to be reasonable cause for the misstatement on the tax return. The courts have applied this standard strictly. List three or more assertions for a waiver of a taxpayer penalty that courts have found not to constitute reasonable cause. Example: Ignorance of the tax law.

12. The taxpayer or a tax advisor may be subject to penalties if there is a misstatement of the valuation of an item reported on the tax return. Describe how these penalties work.

13. Some taxpayers must make quarterly estimated payments of their income tax. Describe the structure of these requirements. In your answer, include both corporate and non-corporate taxpayers.

14. How is the tax law affected by Federal criminal statutes?

15. Circular 230 requires that the tax practitioner use the “best practices” of the tax profession in carrying out a tax engagement. Specify what some of these best practices entail.

16. Carole, a CPA, feels that she cannot act as an aggressive advocate for tax clients in today’s environment. What aspects of the ethical conduct of a tax practice might have influenced Carole’s attitude?

17. Does the tax preparer enjoy an “attorney-client privilege” of confidentiality with his or her clients?

18. CPA Jennifer has heard about the AICPA’s Statements on Standards for Tax Services. Although Jennifer is a licensed CPA in her state, she is not a member of the AICPA. How do the Statements affect Jennifer’s tax practice?

19. The client has decided to dispute the Revenue Agent’s Report. What is the tax advisor’s next step?

Chapter 17Answer Section

TRUE/FALSE

1. ANS: T PTS: 1 DIF: 1 REF: p. 17-2OBJ: 1 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min

2. ANS: TThe IRS budget exceeds $12 billion.

PTS: 1 DIF: 1 REF: p. 17-3 OBJ: 1NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min

3. ANS: FThe overall Form 1040 audit rate is about 1% per year.

PTS: 1 DIF: 1 REF: p. 17-3 OBJ: 1 | 3NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min

4. ANS: FThe high-income rate is about four times the overall audit rate.

PTS: 1 DIF: 1 REF: p. 17-3 | p. 17-7OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min

5. ANS: T PTS: 1 DIF: 1 REF: p. 17-3OBJ: 1 | 3 NAT: AICPA FN-Reporting | AACSB AnalyticMSC: 2 min

6. ANS: T PTS: 1 DIF: 1 REF: Figure 17.1OBJ: 1 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min

7. ANS: FThe operating divisions are organized by type of tax return, e.g., Large Business and International.

PTS: 1 DIF: 1 REF: Figure 17.1 OBJ: 1NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min

8. ANS: TA letter ruling is precedent only for the taxpayer who requested it.

PTS: 1 DIF: 1 REF: p. 17-4 OBJ: 2NAT: AICPA FN-Research | AACSB Analytic MSC: 2 min

9. ANS: FA ruling will not be issued concerning certain issues or fact patterns.


10. ANS: FA significant processing fee is charged.


11. ANS: TThe taxpayer must retain adequate records to support the tax return data.


12. ANS: FFor most tax litigation, the burden of proof shifts to the IRS.


13. ANS: FThat period is 90 days long.


14. ANS: FAn office audit occurs at the IRS’s office.


15. ANS: FThat document is the 30-day letter.

PTS: 1 DIF: 1 REF: p. 17-12 OBJ: 4NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min

16. ANS: TThe government does not publish the decisions of the Small Cases Division.



18. ANS: FThe penalties cannot overlap.

PTS: 1 DIF: 1 REF: Example 12 OBJ: 6NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min

19. ANS: FSuch behavior usually does not excuse the taxpayer’s penalty.

PTS: 1 DIF: 1 REF: p. 17-17 OBJ: 6NAT: AICPA FN-Risk Analysis | AACSB Analytic MSC: 2 min


21. ANS: FSuch behavior usually does not excuse the taxpayer’s penalty.


22. ANS: FThe threshold amount for application of the penalty is $5,000.


23. ANS: T PTS: 1 DIF: 1 REF: p. 17-20OBJ: 6 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 2 min

24. ANS: FThe burden of proof is upon the IRS to show guilt, and not on the taxpayer to show innocence.


25. ANS: FThe statute of limitations never expires if no return has been filed.


26. ANS: TThe 6-year statute of limitations applies to substantial (>25%) omissions of gross income.

PTS: 1 DIF: 1 REF: Example 15 OBJ: 7NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min

27. ANS: T PTS: 1 DIF: 1 REF: p. 17-24OBJ: 7 NAT: AICPA FN-Reporting | AACSB AnalyticMSC: 2 min

28. ANS: TRepresentation is available from members of the filer’s immediate family, if the return was prepared for no compensation.


29. ANS: TCircular 230 applies to all parties who prepare tax returns for compensation.


30. ANS: TThese are the due diligence and best practices requirements.


31. ANS: TContingent fees are allowed only for an audited or amended return.


32. ANS: FThis action constitutes the unauthorized practice of law.


33. ANS: T PTS: 1 DIF: 1 REF: p. 17-26OBJ: 8 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 2 min

34. ANS: T PTS: 1 DIF: 1 REF: Example 19OBJ: 8 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 2 min

35. ANS: TThe penalties apply to most parties who prepare tax returns for compensation.


36. ANS: FThe penalty is the greater of $1,000 or one-half of Latrelle’s fee for preparing the return ($1,500).


37. ANS: TThat privilege has some strict limits.


38. ANS: TSince they are promulgated by the AICPA, application is limited to member CPAs.


39. ANS: TThe Standards are enforceable.


40. ANS: TThe position must be taken in good faith and have a realistic possibility of withstanding judicial scrutiny.

PTS: 1 DIF: 1 REF: p. 17-30 | SSTS 1OBJ: 8 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 2 min

41. ANS: FA CPA need not verify all information that is furnished by the client, although reasonable inquiries are required if the information appears to be incorrect or incomplete.


42. ANS: F

Reasonable estimates are allowed.


43. ANS: FEstimates are allowed under SSTS 4, but only if they are reasonable under the circumstances.


44. ANS: FEstimates are allowed under the Standards, but only if it is impracticable to obtain the precise data. Gracie should have Henrietta produce the information from the accounting software.


45. ANS: FThe CPA should advise the client (not the IRS) of the error.

PTS: 1 DIF: 1 REF: Example 25 OBJ: 8NAT: AICPA FN-Risk Analysis | AACSB Analytic MSC: 2 min

46. ANS: TThe tax professional probably has greater control over the audit process at this location.


47. ANS: TThis procedure is advisable when the taxpayer wants assurance as to tax results that are needed for other taxpayers and for future tax years.


MULTIPLE CHOICE

1. ANS: D PTS: 1 DIF: 1 REF: p. 17-4OBJ: 1 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 5 min

2. ANS: CLetter rulings are open to public inspection after identifying details and certain confidential information have been deleted. Such rulings are reprinted and published by the commercial tax services, available in full text by subscription.

PTS: 1 DIF: 1 REF: p. 17-4 | p. 17-5OBJ: 2 NAT: AICPA FN-Research | AACSB AnalyticMSC: 5 min

3. ANS: B

The IRS does not disclose its audit selection techniques, p. 17-7. As to option a., Example 7. As to option c., p. 17-8. As to option d., Table 17.1.

PTS: 1 DIF: 2 REF: p. 17-7 to 17-10 | p. 17-22 to 17-24 | Example 7OBJ: 3 | 4 | 7 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 5 min

4. ANS: A PTS: 1 DIF: 1 REF: p. 17-9 | p. 17-10OBJ: 3 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 5 min

5. ANS: D PTS: 1 DIF: 1 REF: p. 17-13OBJ: 4 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 5 min

6. ANS: DThe procedure for determining the rate of interest (option a.) is set forth in § 6621(b). The semiannual rule (option d.) was formerly the case, but quarterly changes and daily compounding are now used. Option c. is correct only for corporate taxpayers.

PTS: 1 DIF: 1 REF: p. 17-14 | p. 17-15OBJ: 5 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 5 min

7. ANS: C PTS: 1 DIF: 1 REF: p. 17-17 | p. 17-18OBJ: 6 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 5 min

8. ANS: D PTS: 1 DIF: 1 REF: p. 17-18OBJ: 6 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 5 min

9. ANS: DThe penalty does not apply since the tax underpayment is less than $5,000.


10. ANS: DAdditional tax ($3,500) is less than the $5,000 required to assess the penalty.


11. ANS: DReported valuation is not at least 150% of correct value.


12. ANS: B$35,000 (additional tax) 20% (penalty rate for overvaluation) = $7,000.


13. ANS: B$245,000 (additional tax) 40% (penalty rate for gross overvaluation) = $98,000 penalty.

PTS: 1 DIF: 1 REF: Example 13 OBJ: 6

NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min14. ANS: D

Additional tax ($18,000) exceeds $5,000, but the reported valuation is not 65% or less than the correct valuation.


15. ANS: D$112,500 additional tax 40% penalty rate for gross undervaluation.


16. ANS: B$67,500 additional tax 20% penalty rate.


17. ANS: BThe standard is whether the appraiser knew or should have known of the use on a tax return.


18. ANS: A PTS: 1 DIF: 1 REF: p. 17-20OBJ: 6 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 5 min


20. ANS: CThe prior-year method is not available because no return was filed.


21. ANS: ABy using the prior-year’s tax liability exception ($0 in Mickey’s case), no penalty for underpayment of estimated tax applies. The full $20,000 can be paid with the return.


22. ANS: DOption a. has no statute of limitations. Option b. has a seven-year statute of limitations. Option c. has a six-year statute of limitations.

PTS: 1 DIF: 1 REF: p. 17-22 | p. 17-23OBJ: 7 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 5 min

23. ANS: C[25% ($800,000+ $30,000) = $207,500.]


NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min24. ANS: D

Sally may represent Vera for Year 1 but such representation may not extend beyond the agent level (option a.). The same is true regarding Wesley, for Year 2 (option b.). Alex may represent Vera fully for all years (option c.).

PTS: 1 DIF: 1 REF: Example 17 OBJ: 8NAT: AICPA FN-Risk Analysis | AACSB Analytic MSC: 5 min


26. ANS: BChoice a. is a frivolous return position. Choice c. represents an unconscionable fee. As to choice b., the advertising of tax services is not prohibited by Circular 230.


27. ANS: B PTS: 1 DIF: 1 REF: p. 17-26OBJ: 8 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 5 min


29. ANS: C PTS: 1 DIF: 1 REF: p. 17-27 | p. 17-28OBJ: 8 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 5 min

30. ANS: C PTS: 1 DIF: 1 REF: p. 17-27 | p. 17-28OBJ: 8 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 5 min

31. ANS: CThe penalty for willful and reckless conduct is the greater of $5,000 or one-half of the preparer’s fee.


32. ANS: BThe solution assumes that the CPA is not also a practicing attorney.



MATCHING

1. ANS: E PTS: 1 DIF: 1 REF: p. 17-16 to 17-22 | p. 17-26OBJ: 6 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min

2. ANS: F PTS: 1 DIF: 1 REF: p. 17-16 to 17-22 | p. 17-26OBJ: 6 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min

3. ANS: D PTS: 1 DIF: 1 REF: p. 17-16 to 17-22 | p. 17-26OBJ: 6 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min

4. ANS: H PTS: 1 DIF: 1 REF: p. 17-16 to 17-22 | p. 17-26OBJ: 6 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min

5. ANS: H PTS: 1 DIF: 1 REF: p. 17-20OBJ: 6 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min

6. ANS: B PTS: 1 DIF: 1 REF: p. 17-21OBJ: 6 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min

7. ANS: G PTS: 1 DIF: 1 REF: p. 17-20OBJ: 6 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min

8. ANS: I PTS: 1 DIF: 1 REF: p. 17-21OBJ: 6 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min

9. ANS: J PTS: 1 DIF: 1 REF: p. 17-18OBJ: 6 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min


11. ANS: A PTS: 1 DIF: 1 REF: p. 17-18OBJ: 6 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 2 min

12. ANS: C PTS: 1 DIF: 1 REF: p. 17-18OBJ: 6 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 2 min



15. ANS: A PTS: 1 DIF: 1 REF: p. 17-20OBJ: 6 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 2 min




COMPLETION

1. ANS: Treasury


2. ANS:1, 9one, nine

PTS: 1 DIF: 1 REF: p. 17-3 OBJ: 1 | 3NAT: AICPA FN-Risk Analysis | AACSB Analytic MSC: 2 min

3. ANS:85,00087,50090,000


4. ANS:300three hundred

PTS: 1 DIF: 1 REF: Tax in the News on p. 17-3OBJ: 1 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min

5. ANS: 145


6. ANS: Commissioner

PTS: 1 DIF: 1 REF: Figure 17.1 OBJ: 1NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min

7. ANS: Chief Counsel


8. ANS: letter ruling


9. ANS: determination letter


NAT: AICPA FN-Research | AACSB Analytic MSC: 2 min10. ANS: books and records


11. ANS:90ninety

PTS: 1 DIF: 1 REF: p. 17-7 OBJ: 2 | 3NAT: AICPA FN-Risk Analysis | AACSB Analytic MSC: 2 min

12. ANS: levy


13. ANS:15, 500, 30fifteen, five hundred, thirty


14. ANS: DIF


15. ANS: field


16. ANS: 10,000


17. ANS:50,000fifty thousand


18. ANS: installment plan


19. ANS: 45


20. ANS:civil, criminalcriminal, civil


21. ANS: reasonable cause


22. ANS: negligence


23. ANS: disclose


24. ANS: substantial authority


25. ANS:20, 150Twenty, one hundred fifty


26. ANS: appraisal


27. ANS:10, 125ten, one hundred twenty five


28. ANS:20twenty


29. ANS:500five hundred


30. ANS:110, 90one hundred ten, ninety


31. ANS:3, 6, 7three, six, seven


32. ANS: 1040X


33. ANS: enrolled agent


34. ANS: Circular 230


35. ANS: frivolous


36. ANS: preparer


37. ANS: one-half


38. ANS:50fifty


39. ANS: tax


40. ANS: lottery


41. ANS: AICPA


PROBLEM

1. ANS: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% 2 months $500 tax due = $50, but apply the larger $135 minimum penalty.

b. 5% 3 months $2,000 tax due = $300 penalty.

c. 5% 5 months maximum $10,000 tax due = $2,500 penalty.

d. 15% 3 months $10,000 tax due = $4,500 penalty.

e. 15% 15 months $10,000 tax due = $22,500, but limited to 75% of the tax due = $7,500.


2. ANS:The failure to pay penalty is 0.5% per month of the tax due, with a maximum penalty of 25% of the unpaid tax.

a. 0.5% 2 months $5,000 tax due = $50 penalty (no minimum amount).

b. 0.5% 10 months $5,000 tax due = $250 penalty.

c. 0.5% 50 months maximum $5,000 tax due = $1,250 penalty.


3. ANS:Failure to Pay

Underpayment $10,000 Penalty rate 0.005 Penalty per month outstanding $ 50 Months late 8 Penalty $ 400

Failure to File

Underpayment $10,000 Penalty rate 0.05 Penalty per month outstanding $ 500 Months late 2 Penalty before reduction $ 1,000

Less: Concomitant failure to pay penalty (2 months $50) (100)Penalty $ 900

The failure to file penalty applies from the extended due date of the return, two months 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 eight months.


4. ANS:The penalties cannot overlap. They apply to every month or portion of month of late filing.

Failure to pay penalty (1/2% $5,000) 2 months $ 50Plus: Failure to file penalty (5% $5,000) 2 months $500 Less: Failure to pay penalty for same period (50) 450Total penalties $500


5. ANS:a. The penalties cannot overlap. They apply to every month or portion of month of late filing.

Failure to pay penalty (1/2% $20,000) 10 months $1,000Plus: Failure to file penalty (5% $20,000) 4 months $4,000 Less: Failure to pay penalty for same period (400) 3,600Total penalties $4,600

The failure to file penalty cannot exceed a total of 25%. Consequently, this penalty ceases to increase after 5 months (i.e., 5% 5 months = 25%). The failure to pay penalty also is 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.

b. No. Reliance by a taxpayer on a CPA generally does not constitute reasonable cause so as to avoid the failure to file and pay penalties. The CPA may incur preparer penalties, as well.

PTS: 2 DIF: 3 REF: p. 17-16 | p. 17-17 | Example 12 | Footnote 26OBJ: 6 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 10 min

6. ANS:$3,000 (20% $15,000).


7. ANS:Penalty attributable to civil fraud (75% $160,000) $120,000Penalty attributable to negligence (20% $90,000) 18,000Total penalties $138,000

If the underpayment is partially attributable to negligence and partially attributable to fraud, the fraud penalty is applied first. The negligence penalty then applies to the remaining deficiency.


8. ANS:a. $0. Additional tax ($3,500) is less than $5,000.

b. $0. Additional tax ($7,000) is less than $10,000.

c. $7,000 additional tax 40% penalty rate for gross overvaluation (reported value is overstated by at least 200%) = $2,800 penalty assessed. The $10,000 maximum is only available to C corporations.

d. $26,250 additional tax 20% penalty rate = $5,250 penalty. Reported valuation ($175,000) is at least 150% of correct value ($100,000).

e. $52,500 additional tax 40% penalty rate for gross overvaluation (reported value is overstated by at least 200%) = $21,000 penalty assessed.

f. $140,000 additional tax 40% penalty rate for gross overvaluation (reported value is overstated by at least 200%) = $56,000 penalty assessed.


9. ANS:a. $0. Additional tax ($4,500) is less than $5,000.

b. $3,600. Valuation claimed ($60,000) is 65% or less of the correct value ($100,000).

c. $31,500 additional tax 20% penalty rate = $6,300 penalty assessed.

d. $112,500 additional tax 40% penalty rate for gross undervaluation (reported value is 40% or less than the correct value) = $45,000 penalty assessed.


10. ANS:The § 6662 penalty applies when the tax understatement exceeds $5,000 and the valuation used is 150% or more of the correct value.

Arnold’s underpayment is $7,000 (35% tax bracket $20,000 overvaluation), but the value used is only 140% of the correct value. Thus, the penalty for overvaluation does not apply and only the understated tax of $7,000 is due.


11. ANS:Current-Year Method

First Quarter Payment [($80,000 tax ÷ 4 payments) 90% required)] $18,000Second Quarter Payment 18,000Third Quarter Payment 18,000Fourth Quarter Payment 18,000

Prior-Year Method

First Quarter Payment [($60,000 ÷ 4) 110% required] $16,500Second Quarter Payment 16,500Third Quarter Payment 16,500Fourth Quarter Payment 16,500

Thus, Carol will use the payment schedule of the prior-year method. The remaining tax ($80,000 – $66,000 = $14,000) is due with the return, but no underpayment penalty is assessed.


12. ANS:a. Current-Year Method

First Quarter Payment [($340,000 tax ÷ 4 payments) 100% required] $ 85,000Second Quarter Payment 85,000Third Quarter Payment 85,000Fourth Quarter Payment 85,000Total payments $340,000

Cannot use the prior-year exception; no positive tax on last year’s return. Each payment is $85,000.

b. Prior-Year Method

First Quarter Payment $ 59,500Second Quarter Payment 59,500Third Quarter Payment 59,500Fourth Quarter Payment 59,500Total payments $238,000

Use the prior-year exception. Thus, each payment = 25% $238,000 = $59,500. The remaining liability of $102,000 ($340,000 – $238,000 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% $22,250) $ 5,563Second Quarter Payment ($85,000 2 = $170,000 due – $5,563 paid first quarter)

164,437

Third Quarter Payment 85,000Fourth Quarter Payment 85,000

$340,000

The basic payment is 25% $340,000 = $85,000. Square is a “large corporation,” so it can use the prior-year exception, but only on its first quarter payment. Any underpayments from

the first quarter are due with the second installment.


13. ANS:Payroll withholdings of $100,000 or more must be deposited by the employer by the close of the next banking day. Troy’s withholdings are delinquent as of July 2. Reg. § 31.6302-1(c)(3)

A $200,000 (100% of undeposited taxes) penalty is due from Troy. In addition to criminal penalties that may apply, Troy still owes the $200,000 undeposited tax plus other amounts. Interest computations will accrue. But other penalties, like those for negligence or fraud, do not apply when the 100% penalty is due. § 6672(a)

The IRS alternatively can assess these underpayments of Troy and all of its “responsible persons,” typically corporate officers and directors. Consequently, this is not an effective way to borrow money for capital improvements.


14. ANS:A taxpayer must omit an amount of gross income that exceeds 25% of the gross income stated on the tax return, before the six-year statute of limitations applies. This rule affects gross income items only, (i.e., not deductions and exclusions such as cost of sales). For this purpose, capital gains and losses are not netted together. Here, the three-year statute applies until the gross income omission exceeds $900,000 [($3,500,000 + $100,000) 25%].


15. ANS:The potential § 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 tax preparer’s fee for working on 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 also 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 (%)

Yin-Li’s fee to complete the Cloves return

($)

Amount of preparer

penalty ($)

a. No 40,000 75 10,000 0. Substantial authority for the position.

b. No 50,000 30 800 1,000. No substantial authority, no disclosure.

c. No 60,000 30 5,000 2,500. No

substantial authority, no disclosure.

d. Yes 70,000 30 5,000 0. No substantial authority, but disclosure was made.

e. Yes 80,000 10 5,000 2,500. No reasonable basis.


ESSAY

1. ANS:The tax practitioner needs to study the workings of the IRS so as to:

Be able to apply and use to the taxpayer’s advantage the administration process and the opportunities for appeal provided by the law.

Understand the negative sanctions, such as penalties and interest, that may be brought to bear when the taxpayer is unsuccessful in taking a tax return position.

Apply the ethical and professional constraints that relate to the advice that a tax practitioner gives to a client.

PTS: 1 DIF: 1 REF: p. 17-2 OBJ: 1 | 3 | 8NAT: AICPA FN-Risk Analysis | AACSB Analytic MSC: 5 min

2. ANS:Both the Commissioner and the Chief Counsel are presidential appointees.

The Commissioner is in charge of the day-to-day operations of the agency. The agency is organized into four operating divisions, mainly by the types of tax return that they review. Additional functions include shared services, litigation, investigations, and taxpayer relations.

The Chief Counsel functions as the IRS’ attorney. As the agency’s chief legal officer, the Chief Counsel establishes the IRS positions as to tax matters, drafts guidance for taxpayers and IRS personnel, issues technical rulings on tax matters, and represents the IRS in all tax litigation.

PTS: 1 DIF: 1 REF: p. 17-4 | Figure 17.1OBJ: 1 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 5 min

3. ANS:The IRS has engaged in the following initiatives, among others.

Developing forms and processes for information reporting and document matching.

Using the penalty structure to gain the cooperation of the tax practitioners.

Increasing audit rates for upper-income taxpayers.

Increasing overall audit and enforcement efforts.

Restructuring its operations.

Adopting auditing techniques so as to discourage tax shelters, non-filing, and off-shore investments.

As to business taxpayers, the following audit targets are in place.

Transfer pricing.

Employment taxes.

Application of the § 199 domestic production activities deduction.

Transfers off-shore of intangible assets.

Executive compensation and retirement plans.

Claims of the research credit.

Timing of stock option transactions.

Abuse of the rules for tax-exempt entities.


4. ANS:From the taxpayer’s point of view, the IRS advance rulings program reduces the uncertainty of potential tax consequences resulting from a proposed course of action and, therefore, facilitates tax planning. In addition, the issuance of published rulings permits taxpayers better to understand the position of the IRS on a given issue (e.g., in the event of subsequent audit of a completed transaction which is currently being proposed).

From the standpoint of the government, the IRS ruling policy is an attempt to promote a uniform application of the tax laws. In addition, rulings may reduce the volume of litigation or number of disputes with revenue agents which otherwise would result. The issuance of advance rulings also gives the IRS a better awareness of significant transactions being consummated by taxpayers.

PTS: 1 DIF: 1 REF: p. 17-4 | p. 17-5OBJ: 2 NAT: AICPA FN-Research | AACSB AnalyticMSC: 10 min

5. ANS:a. A determination letter relates to a completed transaction, and its application to the tax law.

The National Office discloses its position as to a taxpayer’s inquiry into, say, whether a

retirement plan qualifies for tax deferred treatment.

b. A technical advice memorandum (TAM) relates to an item that is disputed during an IRS audit. The revenue agent or other IRS personnel requests a ruling as to, say, whether a deduction or credit should be allowed.

c. A technical expedited advice memorandum produces a ruling from the IRS in a shorter time than would be the case for a TAM. The parties stipulate to an agreed set of facts and hold a presubmission conference, so as to clarify and limit the issues that are in dispute.


6. ANS:These circumstances likely increase one’s chances to be audited this year.

Type of tax return: high-income, self-employed, cash-oriented

Information returns do not match contents of the tax return

Itemized deductions claimed in excess of national averages

A claim for refund is involved

Subject of an IRS industry target program (e.g., returns with passive losses, returns of physicians)

Notification provided by an informant or whistleblower

Identified by IRS audit staff from other information sources (e.g., newspapers, web pages, other Federal government agencies)


7. ANS:The IRS benefits when the e-filing process is used, because the filing software eliminates math errors and clarifies ambiguous disclosures by the taxpayer before the return even is accepted by the government.

Taxpayers gain when the e-filing process is used, because their returns are processed by the government in less than half the time needed for a paper-based return. E-filing can be seen as a “green” alternative, in that less paper, ink, and toner might be required to file a return. Postage costs, and the time that one spends waiting in line at the post office, are eliminated. And, because most e-filed returns use a direct deposit system for refunds, the taxpayer has much quicker access to his/her funds after filing the return.

The IRS is encouraging tax practitioners to eliminate their fees for filing tax returns electronically, especially for low-income taxpayers, and the agency may provide its own filing portal to facilitate the “free filing” idea. Further growth in the number of e-filed returns may come from those 40 million individuals who use software to prepare the Form 1040, but who then print the return and mail it to the IRS.

PTS: 1 DIF: 1 REF: Tax in the News on p. 17-9OBJ: 3 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 10 min

8. ANS:The taxpayer may attempt to negotiate an administrative settlement with the Appeals Division of the IRS. A settlement, in part or in whole, may be possible at this level of administrative appeal because the Appeals Officer may settle issues based on the hazards of litigation, whereas an agent must adhere strictly to IRS policy as reflected in published court cases and Treasury Rulings, Regulations and other releases. It also may be possible to reach an overall favorable settlement through a “trading” of disputed issues.

PTS: 1 DIF: 2 REF: p. 17-11 | p. 17-12 | Example 7OBJ: 3 | 4 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 10 min

9. ANS:These observations can be made about the use of interest in the IRS’ management of tax liabilities.

Interest can be paid by the IRS or by the taxpayer, whichever owes the disputed tax.

Interest rates are set quarterly by the Treasury, to approximate the rates found in current financial markets.

One percentage point is subtracted from the norm in computing the rate paid for corporate overpayments.

Interest is compounded daily.

Interest is not payable by the IRS if the refund due is outstanding for 45 days or less.

Refund claims must be made in processible form (i.e., it must be on a form that is readable by the IRS and containing sufficient information to substantiate the claim).


10. ANS:The defenses to the imposition of the penalty include the following.

The taxpayer has substantial authority for such treatment;

The relevant facts affecting the treatment are adequately disclosed in the return on Form 8275; and,

The taxpayer has a reasonable basis for taking the disputed position.


11. ANS:Courts have found the following taxpayer assertions not to constitute reasonable cause.

Delegation of the filing responsibility to a third party, with little or no review of the return or of

the act of filing.

Lack of information as of the due date of the return.

Illness that did not incapacitate the taxpayer.

Refusal of the taxpayer’s spouse to cooperate on a joint return.

Misunderstanding of the tax law.


12. ANS:Several penalties might arise with respect to valuation questions on a tax return.

An overvaluation penalty might be imposed when the taxpayer, say, overstates the amount of a deduction. The basic penalty is 20% of the tax reduction that resulted from the overvaluation. Defenses to the penalty include reasonable cause and good faith efforts.

An undervaluation penalty might arise when the taxpayer, say, understates the value of an asset on an estate or gift tax return. The basic penalty is 20% of the tax reduction that resulted from the undervaluation. Defenses to the penalty include reasonable cause and good faith efforts.

A penalty can be assessed on an appraiser where it was more likely than not that the appraised value used on a tax return was improper. The basic penalty is 10% of the understated tax attributable to the appraisal. This penalty is assessed in addition to the taxpayer valuation penalties discussed above.

PTS: 2 DIF: 1 REF: p. 17-18 to 17-20OBJ: 6 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 10 min

13. ANS:C corporations must make estimates when their tax liability is a least $500. For all other taxpayers, this amount is $1,000. The payments are due on the fifteenth day of April, June, September, and the succeeding January, for calendar year taxpayers. A calendar year C corporation makes its fourth quarter payment by December 15 of the tax year.

A taxpayer other than a C corporation must remit at least 90% of the current year tax or 100% of the prior year tax. The 100% requirement becomes 110% if an individual’s prior-year AGI exceeds $150,000. For the prior-year method, a return must have been submitted for a full twelve-month tax year.

A C corporation must remit at least 100% of the current year tax or 100% of the prior year tax. For the prior-year method, a nonzero tax amount must have been shown on a tax return submitted for a full twelve-month tax year. Large corporations can use the prior-year method only on the first quarter payment.

The penalties are assessed on a quarterly basis. Annualized income computations may be used by the taxpayer to compute the quarterly tax amount due.


14. ANS:A series of criminal penalties are assessed from taxpayers who repeatedly and willfully act to defeat a Federal tax. Criminal penalties bring about fines and potential imprisonment for the offending taxpayer. Criminal tax cases are rare, and they are carried out through the usual criminal justice system, where the taxpayer must be found guilty “beyond the shadow of any reasonable doubt.”

To avoid a criminal tax penalty, the taxpayer needs to create a degree of doubt as to his/her guilt, with the court or jury. Thus, the taxpayer might assert that he/she was confused or ignorant of how the tax law applied, or that he/she relied on the erroneous advice of a competent tax advisor. Another defense against a criminal tax penalty is the inability to plan and execute an evasion of taxes, say due to a mental disease or limitation.

Other violations of the Federal criminal code might arise in the context of filing tax returns, including:

Making a false claim against the Federal government.

Participating in a conspiracy to evade Federal taxes.

Making a false statement to the Federal government, or filing a false document, i.e., perjury.


15. ANS:Tax advisors are to provide clients with the highest quality representation as to Federal tax issues. In addition to other ethical standards, the tax advisor must:

Communicate clearly with the client as to the terms of the engagement.

Identify pertinent assumptions, gather relevant facts, and apply the tax law properly, to arrive at supportable conclusions and recommendations for the client.

Act fairly and with integrity in practice before the IRS.

Inform the client as to risks and penalties that might arise as a result of a recommended course of action.

Apply these best practices in all of the firm’s undertakings.


16. ANS:Carole might be reacting to the general increase in the regulation of the tax profession that has occurred in the last decade. Due to more aggressive pressure from Congress to close the tax gap and public demands for transparency after the Enron and other reporting disasters, there have developed greater pro-government influences on the ethical conduct of a tax practitioner. These include some of the following items.

Increased disclosure standards to avoid preparer penalties (e.g., taking unreasonable tax return positions).

Increased dollar amounts of certain preparer penalties.

Penalties assessed for the actions of appraisers, attorneys, and other parties conceivably involved in a tax understatement.

Penalty assessed for any disallowed refund claim.

Limitations on the CPA/taxpayer confidentiality privilege.

PTS: 1 DIF: 2 REF: p. 17-25 to 17-29OBJ: 8 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 10 min

17. ANS:A limited confidentiality privilege is granted to non-attorneys with respect to tax-related work. The privilege applies only with respect to contacts with the IRS, and not with other Federal agencies such as the SEC. The privilege does not apply with respect to either criminal charges or transactions involving tax shelters. The tax preparer’s privilege corresponds with that which would be available between an attorney and his/her client in the relevant U.S. state.

The privilege relates to the preparation of a Federal tax return while business and other tax advice are not protected.

The privilege does not protect the tax professional’s “tax accrual workpapers” prepared for a client, since these relate to the preparation of financial statements. See Chapter 14.


18. ANS:The Statements are enforceable standards of practice for AICPA members who are involved in a Federal or state/local tax practice. As Jennifer is not a member of the AICPA, the Statements are not binding on her. Nevertheless, she is subject to her state’s ethical rules applicable to CPAs and to those contained in Circular 230, as well as the penalty provisions included in the Code.


19. ANS:Carrying out a level of due diligence in preparing for such a proceeding is part of the tax professional’s responsibility in representing the client.

Make certain that both sides agree on the issues to be resolved in the audit. The goal here is to bring closure to the agent’s list of open issues.

Identify all of the facts underlying the issues in dispute, including those favorable to the IRS. Gather evidence to support the taxpayer’s position, and evaluate the evidence supporting the other side.

Derive current tax law authorities as they bear on the facts and open issues. Remember that the

IRS agent is bound only by Supreme Court cases and IRS pronouncements. Determine here the degree of discretion that the IRS is likely to have in disposing of the case.

Prepare a list of points, ranging from those bearing little weight to the core principles upon which the taxpayer’s case may rest, supporting and contradicting that position. Short research memos will be useful as well in the discussion with the agent. Pro-taxpayer points should be mentioned during the discussion and “entered into the record.”

Prepare tax and interest computations as to the effects of points that are in dispute, so that the effects of closing or compromising an issue always can be determined.

Determine a “litigation point” (i.e., at which the taxpayer’s position will be withdrawn from further audit negotiation and taken to the courts). This position should reflect the dollars of tax, interest, and penalty involved, the chances of prevailing in various trial-level courts, and other strategies discussed with the taxpayer. One must have an “end game” strategy for the audit, and thorough tax research is critical in developing that position in this context.

PTS: 2 DIF: 2 REF: p. 17-34 | p. 17-35OBJ: 3 | 4 NAT: AICPA FN-Risk Analysis | AACSB AnalyticMSC: 10 min

Chapter 17.docx

Documents

Transcript of Chapter 17.docx