Chapter 12 Tax Administration & Tax Planning

1. Chapter 12Tax Administration & Tax Planning Income Tax Fundamentals 2013 Student Slides Gerald E. Whittenburg Martha Altus-Buller Steven Gill 2013 Cengage Learning

2. Internal Revenue Service (IRS) • Congress creates tax law and the IRS is charged with enforcing it • Includes assessment and collection departments • Is a branch of the Treasury Department • Is headquartered in Washington DC • Commissioner of IRS is appointed by president and approved by Congress 2013 Cengage Learning

3. IRS Restructuring Act of 1998 • This act sought to structurally and operationally change the IRS by creating operating units along functional lines • Service & Enforcement arm collects taxes and audits tax returns, including two factions: • Small Business/Self-Employed (SB/SE) unit serves SB/SE customers • Wages & Investment (W&I) division helps taxpayers that primarily pay taxes through withholdings comply with applicable laws See Figure 12.1 on page 12-3 for complete IRS organizational chart 2013 Cengage Learning

4. Back Tax Debt Payment Options • IRS wants to help taxpayer work towards resolution and compliance • Can ask for short administrative extension of time to pay debt • Can pay in installments over time • Can craft “offer in compromise” – used when it is unlikely that taxpayer will ever pay debt in full Note: IRS can also place lien on taxpayer’s assets if debt is more than $10,000 2013 Cengage Learning

5. Selection of Returns for Audits • Tax returns are selected for audit based upon a multitude of factors • Correspondence audit – handled by mail and usually involves questions about W-2s/1099s, certain itemized deductions or the earned income credit • Office audit – conducted when individual taxpayer (usually without business involvement) is required to take records to district office to substantiate income, deductions and/or credits • Field audit – conducted when records too extensive to take to IRS office (usually involves taxpayer engaged in business), generally for taxpayers with substantial business activities Note: Most common process for selecting returns for audit is based on statistical sampling, called DIF (Discriminant Function) score 2013 Cengage Learning

6. Failure to File Penalties • If a tax return is not filed by its due date (with extensions), IRS will impose penalties • Penalty of 5% of tax is due per month or 15% if fraudulently failing to file • Limited to 25% in total (or 75% in total if fraudulent) • No penalty if no tax due or refund forthcoming • If tax return is not filed within 60 days of due date (with extensions), minimum penalty is lesser of $135 or total amount of taxes due with return • The failure-to-file penalty is reduced by failure-to-pay penalty, if both penalties apply 2013 Cengage Learning

7. Statute of Limitations • A taxpayer may not amend, nor may the IRS assess additional taxes, on a tax return for which the three year statute of limitations has expired • Exceptions to three year statute • No statute of limitations if it is a fraudulent tax return • There is six year statute of limitations if amount of gross income omitted exceeds 25% of total gross income • Statute of limitations for deduction of a bad debt or worthless security is 7 years 2013 Cengage Learning

8. Tax Confidentiality Privilege • The attorney-client privilege has been extended in limited circumstances to nonattorneys who are authorized to practice in front of the IRS • CPAs and enrolled agents • This may be asserted only in a noncriminal tax proceeding before the IRS or federal courts • This privilege does not extend to written communications between tax practitioner and a corporation in connection with promotion of tax shelter • Does not automatically extend to state tax situations 2013 Cengage Learning

9. Taxpayer Bill of Rights • Document addresses taxpayers rights • Requires the IRS to inform taxpayers of their rights and remedies when dealing with the Service • It provides remedies for resolving disputes with IRS • Has been amended several times since issuance • Part I – Declaration of Taxpayer Rights • Directs taxpayer to other IRS publications for more details • Part II –Examinations, Appeals, Collections & Refunds Note: See pages 12-19 and 12-20 for Taxpayer Bill of Rights 2013 Cengage Learning

10. Tax Planning • Tax planning refers to arranging one’s financial affairs so as to minimize tax liability • There are two types of financial transactions • In an “open” transaction, tax planning may still occur as transaction has not been culminated • In a “closed” transaction, tax consequences are already finalized and presentation to the IRS is limited to identifying facts in the most favorable light possible • Tax planning based on marginal tax rate • This is the rate applied to the “next dollar of income” or the “next dollar of deduction” and should be used when engaging in tax planning (not the average tax rate) • If illegal methods are used, this is called ‘tax evasion’ 2013 Cengage Learning