Accounting 432/732
Outline—Chapter 1
Omit Harary v Blumenthal, Para Technologies Trust, & In Re Withrop Drake Thies
§ 1.01 Introduction
- Federal tax controversies defined: disputes between taxpayers and the Internal Revenue Service.
- Entities involved in the tax controversy process.
Joint Committee on Taxation (US Congress) writes legislative histories of enacted provisions.
Treasury Department issues regulations interpreting the Internal Revenue Code.
Department of Justice litigates all civil cases except Tax Court and all criminal cases.
§ 1.02 A Self-Assessment System of determining taxes.
- “The tax gap”—role of withholding/information matching. Opportunities for fraud—cash basis, transfer pricing, complex law, self-interest and dishonesty.
Withholding—form 941, professional payroll processing services
Information Matching—Forms 1099—DIV,INT,Misc,B,R,G Income, Form 1098 Deductions
Review Mutual Fund Redemption and Independent Contractor Examples
§ 1.03 Internal Revenue Service Organization
- Review Lederman and Mazza Chart on page 6
IRS Chart Goes Here
- Reorganization Plans—underway since 2000, orientation toward groups of taxpayers Four operating divisions—Wages & Investment; Small Business/Self-employed; Large and Mid Size Business: Tax Exempt and Government Entities. 2001 tax law changes and terrorist activities reduce likelihood reorganization will be complete in the near future.
- W & I—4 segments, (1) Communication Assistance, Research & Education CARE, (2) Customer Account Services CAS (Returns & Payments), (3) Compliance—commonly encountered issues—filing status dependency exemptions, tax credits and deductions. (4) W & I Headquarters (Atlanta, GA)
- LMSB—organized into five industry segments—Retailers, Food & Pharmaceutical, Natural Resources, Heavy Manufacturing & Transportation, Communications, Technology & Media.
- TE/GE—pension plans and tax exempt organizations
- Internal support services—Agency wide information systems—Web site for forms/publications/technology. Agency wide shared services—facilities, procurement, and personnel
- Functional Divisions—Chief Counsel (US Treasury, TC Cases). Counsels are present in the operating divisions on the national level and onboth the area and territorial levels, Operating, Appeals—dispute resolution to settle refund/deficiency claims, Criminal Investigation & National Taxpayer Advocate.
- The Oversight Board—9 members, 3 internal, 6 external
§ 1.04 Rulemaking Authority of the Treasury Department and the IRS
- § 7805 (a) provides that the Secretary can “prescribe all needful rules and regulation for enforcement of this code. Rules can be procedural § 301. or interpretive § 1 or 20., etc.
- IRS publishes internal procedural regulations (IRS manual), and guidance:
Rev. Rulings, Rev Procedures, PLR’s, TAM’s.GCM’s, as well as its litigation position.
§ 1.05 Overview of a Federal Tax Controversy
- Review Overview Chart on page 13. Discuss Revenue Agent’s Report and Form 870, Statute of Limitations. Also point out assessment and collection of the deficiency.
Do Problems 1-2 & 1-3
Overview Chart goes here.
§ 1.06 Ethical Restrictions on Tax Practice
- Attorneys, certified public accountants, and enrolled agents may all practice before the tax court. Tax practitioners must be sensitive to a number of different types of rules:
- Preparer Penalties
- Specifically Applicable Rules—Circular 230 Review the highlights on page 29-34, Tax Court rules also apply.
- Generally Applicable Ethics Rules—ABA, AICPA
- Ethical Issues
- Tax Planning
False Opinions—one that ignores or minimizes serious legal risks or misstates facts or the law, knowingly or though gross incompetence. The lawyer who knowingly accepts as true the facts which the promoter tells him, when the lawyer should know that a further inquiry would disclose these facts are untrue also gives false opinion. U.S. vBenjamin 328 F 2d. 854 (CA-2, 1964). Attorneys cannot escape criminal liability on a plea of ignorance “when they shut their eyes to what as plainly to be seen.”
In the past lawyers have protected their clients and themselves in litigation by claiming that communications between them were “privileged”’
Review Taxday article on KPMG (1/10/03)
Ethical Considerations--page 16
ABA has set of general guidelines, also AICPA-generally perceived as “toothless”, Circular 230 has its own set of requirements.
- Return Preparation
Preparer defined: §7701(a)(36)—“ person who prepares for compensation all or a substantial part of an income tax return or refund claim.” (employer also covered)
Do Problem 1-5
§6694(a) $250 penalty for a tax preparer who knew that there was not a realistic possibility that a reported position would be claimed.
§6694 (b) $1,000 penalty for willful understatement of the client’s tax liability or with intentional disregard of the rules and regulations.
Rev Ruling 86-55 describes other important penalties in the law and analysis section:
§6107(a) Tax return preparer has an obligation to furnish a completed copy of the tax return of the taxpayer.
§6107(b) Prepare has an obligation to retain a copy of the return or a list of taxpayers for whom returns have been prepared
§6695(b) imposes an obligation to sign the return—obligation falls on the individual with primary responsibility for the overall substantive accuracy.
§6109(a)(4) provides that any return or claim for refund prepared by an income tax return preparer shall bear such identifying number for securing proper identification .(including employer)
§6060 any person who employs an income tax return preparers to prepare a return or claim for refund other than for that employer must contain a record concerning each preparer so employed.
§6695(f) penalty of $500 on income tax return prepares who endorse or otherwise negotiate refund checks that are issued to taxpayers.
§7216 imposes a criminal penalty for unlawful disclosure or use of return information by persons who prepare or provide services in connection with preparation of returns.
- Tax Controversies
- Attorneys, CPA’s, Enrolled Agents & Enrolled Actuaries
“Practice before the Internal Revenue Service comprehends all matters connected with a presentation to the Internal Revenue Service or any of its officers or employees relating to a client’s rights, privileges, or liabilities under laws or regulations administered by the Internal Revenue Service. Such presentations include preparing and filing necessary documents, corresponding and communicating with the Internal Revenue Service, and representing a client at conferences, hearings and meetings”
- Subpart B of Circular E presents the duties and prohibitions. Duties include (1) submitting records or information upon a proper request by a duly authorized IRS officer or employee, (2) advising a client promptly of any noncompliance, error, or omission in any tax return, affidavit or other legally required document, if the representative is aware of the noncompliance , error, or omission; and (3) exercising due diligence in preparing or assisting in the preparation of, any documents, in determining the correcting of oral or written representations made by him to clients..
Prohibitions—Review highlights from pages 30 and 31
(1, 6, 7, 8, 9)
Subpart C of Circular 230 provides the rules applicable todisciplinary proceedings and provides for suspension and disbarment proceedings.
- Practice before the Tax Court—almost entirely attorneys, others-- by examination
Do Problem 1-8.
§ 1.07 Tensions Between Tax Lawyers and Accountants
- “Why do Lawyers and Accountants Fight?”
What is the AICPA’s position with regard to the CPA’s role in tax practice? What ethical issues does this position raise? How does the AICPA position raise conflicts with the legal profession?
CPA’s and law firms have been accused of overly aggressive tax planning. Do you feel these criticisms are warranted? What changes may we expect in tax practice?
- “What Tax Advice Privilege?”
To what extent does § 7525 extend the attorney-client tax privilege to tax cases? Continuum of services for tax advisers can be seen as continuum between tax return preparation and litigation. Tax planning is in between. Return preparation is not privileged and litigation is protected.
An IRS examination is not litigation and §7525 sent the message that all tax discussions with the IRS are adversarial. Under Circular 230 the Treasury sees the privilege as an exception to the general obligation to turn over all requested records.
Based on the Adlman case a taxpayer who is about to undertake a transaction the IRS may well question can take the position that documents created in analyzing that transaction are a litigation work product and therefore subject to attorney client privilege.
The gray area—between business advice (non protected) and legal advice (protected) Accountants hoped to obtain protection for tax shelter advice but did not achieve it.
Subject Matter Waiver---voluntary disclosure to a third party & materials provided to a taxpayer for use in tax return preparation are not subject to attorney client privilege. This legal right has been waived.
Do Problem 1-10
Chapter 2
Tax Returns and the Examination Process
Omit Beard (pp 60-69), Norwest Corporation (pp 75-84), Ash (pp, 84-93) & Crowley and Cockrell (pp.112-116) & Cheshire (118-122)
§ 2.02 Tax Returns & Tax Payments
- Formal Requirements of a Return
Sufficient return starts the running of the statute of limitations (Blount 86 TC 383 (1986))
Document must be on a proper form (§6011), supply enough information to permit the IRS to calculate the tax, contain the taxpayer’s name, address and ID #, and be properly signed under penalties of perjury (§6061)
Review MBA professor example
The taxpayer must compute the tax unless he makes a special election under § 6014 (< $10,000 gross income& other requirements) to have the IRS compute the tax..
$500 frivolous return penalty when the return omits information on which the substantive correctness of the self-assessment may be judged or (2) contains information that on its face indicates that self-assessment is substantially incorrect, if the conduct is due to a frivolous position or desire to impede the administration of the tax laws.
Review Mickey Mouse example
- Filing Tax Returns
Individual Returns—3 mos 15 days, Corporate--2 mos 15 days, Partnerships & Fiduciary--3mos and 15 days, Tax exempt--4mos & 15 days.
§ 7503-- if the last day falls on a Saturday, Sunday of Legal Holiday, filing is timely if made on the next day that is not a Saturday, Sunday or legal holiday.
Returns are generally considered filed when received by the IRS, also if the requirements of § 7502 are met. (i.e. mailed or sent to a private delivery service prior to due date.) §7502 (c) reduces risk to taxpayer by sending the return by registered or certified mail. Note that the taxpayer cannot send estimated payments by private delivery service. Also the taxpayer should send each return and estimated payment separately.
ReviewTower & Tower practices
Service Centers are the places for filing most documents, remittances go to a separate location..
Return instructions will show where to send. It is critical that the taxpayer conform to the instruction requirements, since the IRS may have difficulty tracing a return or deposit that is send to the wrong locale.
Electronic Filing goal is to have only 20% of returns on paper by 2007. However, these will generally be the most sophisticated returns.
- Filing Extensions
Form 4868 individual gets an automatic 4-month extension. Note that this mitigates the failure to file penalty, but not failure to pay. Review Form 4868.
Additional extension of 90 days is available if the taxpayer can show reasonable cause. Generally this is not a problem. File on Form 2688, Application for Additional Extension of Time to File. Corporations can obtain a 3-month automatic extension by filing Form 7004.
- Amended Returns
The taxpayer has the option of amending his return is he discovers a mistake on the original return. If filed before the due date, the amended return is considered the tax return for that year. If filed after the due date the IRS has the discretion to accept or reject the amended return (note the statute of limitations remains with the original return)
- Tax Payments
Payment is due on the original due date of the return, can be check or
money order in US funds or by debit or credit card. There may be an
extension of the payment date related to “undue hardship” but this is not
common. Note that the withholding and estimated tax requirements results in
the payment of the tax in a timely fashion.
Example: Dot Com AMT Incentive stock option issues.
The taxpayer should note on the check ID # of the payor and the specific
purpose of the payment.
§ 2.03 Examinations
1. §7602 (a)(1) The IRS has very broad authority to “examine any books, papers,
records, or other data which may be relevant” in determining the correctness
of any tax return. § 6201 IRS is authorized to make inquiries, determinations,
and assessments of all taxes under the internal revenue laws. §7602(a)(2)
gives the IRS summons power, which enables the IRS to compel a taxpayer to
produce records or testify under oath. IRS examination personnel are authorized to serve summons.
- Audits
Audit lottery & the raising of revenue—IRS selects returns that raise revenue.
Note the coordinated examination program (CEP) where an IRS agent or agents are permanently assigned to a corporation.
DIF formula is used select returns for audits, as well as claim or refund , and information return matching program, and the “infection” process.
Three types of audits—correspondence, office and field.
Correspondence—most common, conducted by mail. Usually involve revenue items (Form 1099) or withholdings, estimated tax payments or credits.
Office audit—conducted at district office. Taxpayer meets with auditor, brings specific information and documentation. Usually involve large and unusual itemized deductions.
Field audits—conducted by revenue agents at the taxpayer’s place of business
Issues are not as clear.
Partnership Audit Procedures Under TEFRA—enables the IRS to audit a partnership without auditing each partner. Note that this applies to partnerships with more than 10 partners. IRS sends a notice of its adjustment determination, called the FPAA, to the “Tax Matters Partner” and within 60 days to each notice partner (Partner whose name appears on the return). The TMP is the general partner designated to the IRS as such , or general partner having the highest profits interest at the end of the tax year. The TMP has 90 days to petition a trial court, notice partners have another 60 days. This information is important since individuals commonly invest in tax shelters, which are subject to audit adjustment. Taxpayers and their accountants should be cautious when taking on return filing responsibilities.
- Audit Strategy
Correspondence audit—respond quickly and concisely in order to limit the scope of the audit
Office audit—limited in scope, field audit revenue agent may use own discretion . Pages 98-100 discuss some useful strategies in dealing with an audit. Note that if the IRS examiner requests to see books and records, he should issue a Form 4564 (IDR); form is important because it allows attorney to evaluate the request and negotiate its scope and reveals the issues the examiner is considering.
Do Problem 2-2 & 2-5
- Reconstructing Income when the Books and Records are Incomplete
Many methods are available; note that the IRS is not confined to a single approach. Most common are the net worth and specific items methods. Others include: bank transaction, bank deposits, source and application of funds, and T account.
Net worth method—compares net worth at beginning and close of the taxable year. Expenditures + difference = Increase in Net Wealth, Increase in Net Wealth – Non Tax Sources = Unreported Income.
Specific Items method—Focuses on a specific receipt or receipts not included in the taxpayers return.
Schwarzkopf 246 F2d 731 (CA-3, 1957) What method did the IRS use to reconstruct income? What were Schwarzkopf’s principal argument and defense? Did the Court of Appeals agree with the IRS?
Cooper TCM 87-431 What method(s) did the IRS use to reconstruct income?
What was Cooper’s defense? Did the IRS prevail?
Do Problem 2-6A
§ 2.04 Joint Returns and Several Liability
- § 6013(d)(3) In general husband and wife are jointly and severally liable for
any tax year in which they filed a joint return. Congress enacted “innocent spouse” provisions to alleviate the burden on a spouse that did not engage in an activity-giving rise to an understatement of the tax and who was unaware of the understatement. The original code provisions (§ 6013 (e)) resulted in numerous problems of interpretation and in 1998 Congress amended and recodified the provisions as § 6015. This section reflects a major overhaul in both eligibility and procedures for obtaining relief. Spouses who are divorced, legally separated or are no longer living together can elect proportionate liability. Revenue Procedure 2000-15 provides guidance in seeking innocent spouse relief. The taxpayer may elect innocent spouse status by filing form 8857. Taxpayers in community property states must consider the laws of those states in allocating income and expenses. Taxpayers who file MFS can reduce the likelihood of liability for income received by one spouse without the direct knowledge of the other.
Do Problem 2-4.
Chapter 3
Access to IRS Information versus Confidentiality of Taxpayer Information
Omit United States Department of Justice v Tax Analysts (pp 129-143), Church of Scientology (pp 150-154), Diandre v US (pp 160-165), Martin (165-171), Ward (171-176)
§ 3.01 Introduction: The Tension between Confidentiality and Disclosure
Some code section provisions favor taxpayers’ privacy interests while others favor full disclosure by the IRS to the public
§ 3.02 Access to IRS Information
- Disclosure Under the Freedom of Information Act:
- Descriptions of the agency’s organizational structure and operations, procedural rules, available forms and statements of general policy and interpretations. (e.g. publication of temporary & final regulations)
- Information made available by an agency for public inspection and copying, or for sale. (e.g. final opinions, administrative staff manuals and instructions to employees that might affect a member of the public—CCH publishes this information)
Do Problem 3-4
- Records of the agency. Taxpayer must request this information according to published rules. Records includes statistical studies → revenue agent’s report.
- IRS has the burden of justifying failure to make agency records available for inspection. § 552 (b) of 5 USC. Nine exemptions are available but three are particularly important to tax practice: (1) Ex 3—IRS may withhold information if that information is specifically exempted from disclosure by another statute. (e.g. § 6103 seeks to ensure the confidentiality of a taxpayer’s return and tax return information. (2) Ex 5—IRS may refuse to disclose inter-agency or intra-agency memoranda that would not be available by law to a private party in litigation with the IRS (e.g. attorney-client privileges) (3) Ex 7—applies to records or information compiled for law enforcement purposes.
- Using FOIA during the Tax Controversy Process
- The IRS “secret law”—PLR’s, Determination Letters, Chief Counsel Advice, and Action of Decision memoranda are available under § 6110 or FOIA. Also available the Internal Revenue Manual, IRS legal analysis of important issues.
- If the taxpayer wishes to obtain materials that were prepared by the IRS during an audit of the taxpayers’ own return, the taxpayer must make an individual FOIA request. (Access is limited while the examination is progress; once the examination is concluded and the IRS has issued a 30-day letter, the taxpayer may submit a FOIA request seeking access to all materials contained in the taxpayers administrative file This information would be particularly helpful in settling the case in sthe Appeals division.
The administrative file will normally contain a copy of the agent’s working files, including workpapers, notes, intra-agency memoranda, affidavits and interview transcripts. The file also contains all records compiled by the agent during the audit, including records obtained from third parties.