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Chapter 12. Tax Administration and Tax Planning. Objective. Be familiar with the organizational structure of the Internal Revenue Service. Organization of IRS. Congress creates tax law and the IRS enforces it Includes assessment and collection

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Chapter 12

Tax Administration

and Tax Planning

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Be familiar with the organizational structure of the Internal Revenue Service

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Organization of IRS

  • Congress creates tax law and the IRS enforces it

    • Includes assessment and collection

  • IRS is a branch of the Department of the Treasury

  • Commissioner of IRS is appointed by President and approved by Congress

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Organization of IRS

  • Headquartered in Washington DC

  • Regional Commissioners oversee four regional offices in Atlanta, Dallas, New York and San Francisco

  • District offices are located throughout US and report to their respective regional offices

  • Ten service centers are responsible for processing information

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IRS Restructuring Act of 1998

  • Due 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

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Have a general understanding of the IRS audit process

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IRS Audits

  • IRS 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

  • Tax 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)

      • The TCMP has been suspended and the IRS is developing an alternative system to measure compliance

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Audit Appeals

  • There 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

  • In 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

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Know the common penalties for taxpayers and tax preparers and be able to calculate them

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  • Interest is charged to taxpayer for late taxes (for example, prior year audit reveals tax due)

  • Interest is paid to the taxpayer for refund (prior year audit reveals refund due)

  • Interest received from IRS is income; interest paid to IRS by taxpayers is nondeductible consumer interest

  • Interest rate is set at 3 points above the short term federal rate and is adjusted quarterly

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Failure to File Penalties

  • If 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)

  • Minimum penalty if return is filed within 60 days of due date (with extensions)

    • Lesser of $100, or

    • Tax due

  • This penalty is reduced by failure to pay penalty, if both penalties apply

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Other Penalties

  • Failure to Pay Penalty

    • Penalty is 0.5% of tax for each month tax is late

    • Limited to 25% in total

  • Accuracy 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

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Other Penalties (continued)

  • Penalty for failing to file informational returns on a timely basis (1099s, W-2s, etc)

  • Penalty for filing a frivolous tax return

  • Penalty for filing false withholding information

  • Penalty for writing a bad check for taxes

  • Penalty for underpaying estimated taxes

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Know the general rule for the statute of limitations on tax returns

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Statute of Limitations

  • A 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

  • If IRS and taxpayer agree, Form 872 may be signed that allows for extension of statute of limitations

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Tax Preparers

  • Any person compensated for preparing another person’s tax return is “paid tax return preparer”

  • Only CPAs, attorneys or enrolled agents may represent clients at IRS proceedings

  • There are a multitude of penalties if preparer does not conduct business with due diligence, sign returns, provide copy to clients, etc.

  • The 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)

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Be familiar with the process of filing tax returns electronically

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  • Electronic filing is a process of transmitting tax returns by an ERO (electronic return originator) directly to IRS

  • Form 8453 (US Individual Income Tax Declaration for Electronic Filing), with original signatures and forms that cannot be electronically transmitted, must also be mailed

  • Tax preparers may only transmit 5 returns without officially requesting approval to be part of electronic filing system via Form 8633

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Refund Anticipation Loans

  • Taxpayer 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 10-20 days

    • IRS makes no guarantee that refund will not be applied against debt to government, such as defaulted student loans or other tax liens

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Taxpayer Bill of Rights

  • Document addresses taxpayers rights

  • Requires the IRS to inform taxpayers of their rights when dealing with the Service

    • It provides remedies for resolving disputes with the IRS

  • Part I – Declaration of Taxpayer Rights

  • Part II –Examinations, Appeals, Collections & Refunds

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Know the basic concepts of tax planning

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Tax Planning

  • Average tax rate equals total tax paid divided by total income

  • Marginal tax rate is the tax rate on the “next” dollar of income

    • The relevant tax rate for tax planning

  • Tax 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

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Tax Planning (continued)

  • Tax evasion refers to the taxpayer avoiding tax in a manner that is illegal and can result in penalties and/or incarceration

  • Good 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