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Tax Compliance

Chapter 2: Tax Compliance, the IRS, and Tax Authorities

Learning Objectives:

  • Identify the filing requirements for income tax returns and the statute of limitations for assessment.
  • Outline the IRS audit process, how returns are selected, the different types of audits, and what happens after the audit.
  • Evaluate the relative weights of the various tax law sources.
  • Describe the legislative process as it pertains to taxation.
  • Perform the basic steps in tax research and evaluate various tax law sources when faced with ambiguous statutes.
  • Describe tax professional responsibilities in providing tax advice.
  • Identify taxpayer and tax professional penalties.

Taxpayer Filing Requirements

  • filing requirements are specified by law for each type of taxpayer
  • all corporations must file a tax return annually regardless of their taxable income
  • estates and trusts are required to file annual income tax returns if gross income exceeds $600
  • filing requirements for individual taxpayers is a bit more complex – depend on filing status, age, and gross income
  • thresholds are calculated as sum of standard deduction and personal exemptions that apply to each filing status (indexed for inflation and change each year)
  • gross income determines whether a tax return is required

Tax Return Due Date and Extensions

  • due dates are based on type of taxpayer
  • individual returns are due on 15th day of 4th month following year-end (April 15)
  • partnership returns are also due on the 15th day of the 4th month
  • corporations returns must be filed on 15h day of 3rd month following the corporation’s year-end (March 15)
  • due dates that fall on Saturday, Sunday, or holiday are automatically extended to next day that is not a Saturday, Sunday, or holiday
  • can request a six-month extension to file, which is granted automatically by the IRS
  • partnerships may request automatic 5 month extension to file
  • extension allows taxpayer to delay filing a tax return but doesn’t extend the due date for tax payments – must estimate how much tax will be owed
  • if fail to pay entire balance of tax owed, IRS imposes interest on underpayment from due date of return until taxpayer pays the tax
  • interest rate charged depends on taxpayer type and varies quarterly with federal short-term interest rate

Statute of Limitations

  • tax returns may contain mistakes (some may be to taxpayer’s advantage and some to government’s advantage)
  • taxpayer is obligated to file an amended return to correct error if time has not expired for tax return
  • IRS can propose adjustments to return if time has not expired
  • statute of limitations: defines the period in which the taxpayer can file an amended tax return or the IRS can assess a tax deficiency for a specific tax year
  • generally ends 3 years from the later of (1) the date tax return was actually filed or (2) tax return’s original due date
  • for IRS assessment, can be extended in certain circumstances
  • taxpayers should prepare for possibility of audit by retaining all supporting documents (receipts, cancelled checks, etc.) for tax return until statue of limitations expires – afterwards, can discard majority but keep a copy of tax return itself

IRS Audit Selection

  • return is selected for audit because IRS has data suggesting taxpayer’s tax return has high probability of significant understated tax liability
  • fewer than 2% of all tax returns are audited
  • IRS must be strategic in selecting returns for audit in an effort to promote highest level of voluntary taxpayer compliance and increase tax revenues
  • IRS uses number of computer programs and outside data sources to identify tax returns that may have understated tax liability
  • DIF (Discriminant Function) system: assigns a score to each tax return that represents the probability the tax liability on the return has been underreported (higher score = higher likelihood of underreporting)
  • uses weights from historical IRS audit adjustment data to score each tax return based on return’s characteristics
  • returns with higher DIF scores are reviewed to determine whether audit is best course of action
  • document perfection program: checks all returns for mathematical and tax calculation errors
  • information matching program: compares taxpayer’s tax return to info submitted to the IRS from other taxpayers like banks, employers, mutual funds, brokerage companies, and mortgage companies
  • info matched includes wages, interest income, and dividend income
  • IRS recalculates the taxpayer’s tax liability and sends notice explaining adjustment (if owe tax, will request payment due; if overpaid tax, will send refund)
  • IRS may use number of other audit initiatives for identifying tax returns for audit
  • taxpayers of a given size and complexity may be audited every year

Types of Audits

  • correspondence examinations: conducted by mail and generally are limited to one or two items on the taxpayer’s return; are most common
  • narrowest in scope and least complex
  • IRS requests supporting documentation for one or more items on return, like charitable contributions deducted
  • office examinations: IRS conducts these at local office; second most common
  • typically broader in scope and more complex
  • taxpayer receives a notice that identifies items subject to audit; requests substantiation for these items as necessary; notifies taxpayer of date, time, and location of exam
  • taxpayer may attend exam alone, with representation, or let tax adviser/attorney attend on behalf
  • field examination: IRS conducts these at taxpayer’s place of business or location where taxpayer’s books, records, and source documents are maintained; lease common
  • broadest in scope and most complex
  • can last months to years and generally limited to business returns and most complex individual returns

After the Audit

  • IRS agent provides list of proposed adjustments for review
  • if agrees, signs agreement form and pays additional tax owed or receives proposed refund
  • 30-day letter: IRS letter received after an audit that instructs the taxpayer that they have 30 days to either (1) request a conference with appeals officer or (2) agree to proposed adjustment
  • appeals officer would consider merits of unresolved issues as well as “hazards of litigation”
  • 90-day letter: IRS letter received after an audit and receipt of the 30-day letter that explains that the taxpayer has 90 days to either (1) pay the proposed deficiency or (2) file a petition in the US Tax Court to hear the case; is also known as the statutory notice of deficiency
  • US Tax Court: national court whose judges are tax experts and who hear only tax cases
  • US District Court: one of three trial-level courts; is only court that allows a jury trial; at least one district court in each state
  • US Court of Federal Claims: one of three trial-level courts; national court that only hears monetary claims against the federal government
  • if go through either of those courts, taxpayer must pay deficiency first, then request refund from IRS, then sue IRS for refund in court after IRS denies refund claim
  • US Circuit Courts of Appeal: first level of appeals courts after the trial-level courts; 13 US Circuit Courts of Appeal; one for Federal Circuit and 12 assigned to hear cases that originated from a specific circuit
  • US Supreme Court: highest court in the US; only hears a few tax cases a year with great significant to a broad cross-section of taxpayers or cases litigating issues in which there has been disagreement among the circuit courts; refuses to hear case and litigation ends with circuit court decision
  • writ of certiorari: document filed to request the US Supreme Court to hear a case
  • litigation can be very costly financially and emotionally – more appropriate that it’s used as option of last resort

Tax Law Sources

  • primary authorities: official sources of the tax law generated by the legislative branch (statutory authority issued by Congress), judicial branch (rulings by the US District Court, US Tax Court, US Court of Federal Claims, US Circuit Court of Appeals, US Supreme Court), and executive/administrative branch (Treasury and IRS)
  • second authorities: unofficial tax authorities that interpret and explain the primary authorities, such as tax research services, tax articles from professional journals and law reviews, and newsletters
  • may be helpful in understanding a tax issue, but they hold little weight in tax dispute – tax advisers should be careful to verify their understanding of tax law by examining primary authorities directly and to never cite secondary authorities in research memo

Legislative Sources: Congress and the Constitution

  • US Constitution: highest authority in the US, but provides very little in the way of tax law since it contains no discussion of tax rates, taxable income, or other details
  • 16th Amendment provides Congress ability to tax income directly, from whatever source derived, without apportionment across the states

Internal Revenue Code

  • Internal Revenue Code of 1986: codified tax laws of the US; frequently revised, there have only been three different codes since the Code was created in 1939 (1954, 1939)
  • has same authoritative weight as tax treaties and Supreme Court rulings

The Legislative Process for Tax Laws

  • all bills originate in the House of Representatives
  • Senate may propose tax legislation, but first to formally consider a bill will be the House, within its Ways and Means Committee
  • after committee debates the proposed legislation and drafts a bill, goes to the House floor for debate and ultimately a vote
  • if approved, becomes an act and is sent to Senate (refers act to Senate Finance Committee)
  • SFC amends act during deliberations
  • after revised act passes SFC, goes to Senate for debate and vote – senators may modify proposed legislation during debate
  • if Senate passes, both House and Senate versions are sent to Joint Conference Committee
  • after JCC approves act, revised legislation is sent to House and Senate for vote
  • if both approve, act is sent to president for signature
  • if president signs act, becomes law and is incorporated into IRC of 1986
  • if president vetoes legislation, Congress may override the veto with 2/3 positive vote in both House and Senate
  • each committee produces report that explains current tax law, proposed change in law, and reasons for change – considered statutory sources of tax law and may be useful in interpreting tax law changes and Congressional intent

Basic Organization of the Code

  • IRC is segregated into subtitles, chapters, subchapters, parts, subparts, and sections
  • when referencing a tax law, the researcher refers to the law simply by its code section
  • code sections are numbered 1 to 9833, with gaps in section numbers to allow new code sections to be added
  • understanding organization of Code is important
  • code sections addressing similar transactions are grouped together

Tax Treaties

  • tax treaties: negotiated agreements between countries that describe the tax treatment of entities subject to tax in both countries, such as US citizens earning investment income in Spain
  • US president has authority to enter into tax treaty with another country after receiving Senate’s advice
  • if US citizen earning income abroad, need knowledge of US tax laws, foreign country’s tax laws, and respective tax treaty between US and foreign country for effective tax planning

Judicial Sources: The Courts

  • ultimate authority to interpret the Internal Revenue Code and settle disputes between the IRS and taxpayers
  • Supreme Court represents highest tax-specific authority
  • Supreme Court doesn’t establish law, but instead simply interprets and applies the Code
  • Code and Supreme Court should never be in conflict
  • decisions of 13 US Circuit Courts of Appeal represent next highest judicial authority
  • lowest level of judicial authority consists of three different types of trial-level courts (US District Courts, US Court of Federal Claims, and US Tax Court)
  • US Tax Court hears only tax cases and that its judges are “tax experts”, its decisions typically have more weight than those rendered by a district court or the US Court of Federal Claims
  • all courts apply the judicial doctrine of stare decisis: a doctrine meaning that a court will rule consistency with (a) its previous rulings (unless, due to evolving interpretations of the tax law over time, the court decides to overturn an earlier decision) and (b) the rulings of higher courts with appellate jurisdiction (courts its cases are appealed to)
  • implication is that circuit court will abide by Supreme Court rulings and its own rulings, whereas a trial-level court will abide by Supreme Court rulings, its respective circuit court’s rulings, and its own rulings
  • doctrine presents a special problem for US Tax Court because it appeals to different circuit courts based on taxpayer’s residence
  • Golsen rule: states that the tax court will abide by rulings of the circuit court that has appellate jurisdiction for a case

Administrative Sources: The US Treasury

Regulations, Revenue Rulings, and Revenue Procedures

  • Treasury Dept. is charged with administering and interpreting the tax laws of the US, among other duties such as printing money and advising the president on economic issues
  • regulations: Treasury Dept.’s official interpretation of the Internal Revenue Code, have the highest authoritative weight, and often contain examples of the application of the Code that may be particularly helpful to the tax researcher
  • regulations are issued in three different forms
  • final regulations: regulations that have been issued in final form, and thus, unless or until revoked, they represent the Treasury’s interpretation of the Code
  • temporary regulations: limited life (three years for regulations issued after Nov 20, 1988) that carry the same authoritative weight as final regulations
  • proposed regulations: allow public comment on them; do not carry the same authoritative weight as temporary or final regulations
  • serve three basic purposes
  • interpretative regulations: most common regulation; they represent the Treasury’s interpretation of the Code and are issued under the Treasury’s general authority to interpret the Code
  • procedural regulations: regulations that explain Treasury Dept. procedures as they relate to administering the Code
  • legislative regulations: rarest type of regulation, issued when Congress specifically directs the Treasury Dept. to create regulations to address and issue in an area of law; Treasury is actually writing the law instead of interpreting the Code; actually represent tax law instead of an interpretation of tax law, legislative regulations have more authoritative weight than interpretative and procedural regulations
  • revenue rulings: second in administrative authoritative weight after regulations; revenue rulings address the specific application of the Code and regulations to a specific factual situation; have same authoritative weight as revenue procedures
  • binding on the IRS, courts may agree or disagree with revenue ruling
  • revenue procedures: much more detailed than regulations; explain in greater detail IRS practice and procedures in administering the tax law
  • binding on the IRS until revoked, modified, or superseded

Letter Rulings

  • less authoritative but more specific than revenue rulings and regulations
  • may not be used as precedent by taxpayers
  • may be cited as authority to avoid the substantial understatement of tax penalty under IRC Sec. 6662 imposed on taxpayers and related tax practitioner penalty under IRC Sec. 6684
  • private letter rulings: represent the IRS’s application of the Code and other tax authorities to a specific transaction and taxpayer; issued in response to a taxpayer request and are common for proposed transactions with potentially large tax implications
  • IRS maintains a list of certain issues on which it refuses to rule, such as tax consequences of proposed federal tax legislation
  • IRS publishes an updated list of these transactions in a revenue procedure
  • determination letters: issued by local IRS directors; generally not controversial
  • example is request by an employer for IRS to rule that the taxpayer’s retirement plan is a “qualified plan”
  • technical advice memorandums: generated for completed transactions and usually are requested by an IRS agent during an IRS audit
  • IRS and taxpayers litigate tax cases in a number of courts and jurisdictions
  • acquiescence: indicates that IRS has decided to follow the court’s adverse ruling in the future, it doesn’t mean the IRS agrees with it – means IRS will no longer litigate this issue
  • nonacquiescence: exact opposite implications and alerts taxpayers that the IRS does plan to continue to litigate this issue
  • actions of decisions: explain the background reasoning behind an IRS acquiescence or nonacquiescence
  • IRS publications and tax return form instruction can be cited as precedent or relied upon to avoid taxpayer or tax practitioner penalties

Tax Research

  • Code doesn’t specifically address the tax consequences of each transaction type or every possible variation of particular transaction, the application of tax law is subject to debate and differing interpretations by the IRS, courts, tax professionals, taxpayers
  • tax research plays a vital role in allowing us to identify and understand varying authorities that provide guidance on an issue, to assess relative weights of differing authorities, understand risks associated with different tax return positions, and draw an appropriate conclusion regarding application of tax law to issue

Step 1: Understand Facts

  • understand question and know facts
  • two types of facts: open facts and closed facts
  • open facts – have not yet occurred, such as facts associated with proposed transaction
  • closed facts – have already occurred
  • unlike closed facts, open facts can be altered and different facts may result in very different tax consequences
  • open facts allow taxpayer to arrange a transaction to achieve most advantageous outcome – especially important in tax planning
  • interview clients, speak with third parties such as attorneys and brokers, review client documents such as contracts, prior tax returns, wills, trust documents, deeds, and corporate minutes
  • up to tax professional to ask correct initial and follow-up questions to obtain all relevant facts
  • consider nontax factors, such as client’s personal values or objectives – put constraints on tax planning strategies

Step 2: Identify Issues

  • ability to identify issues is largely a function of his/her type of tax expertise
  • tax expert in particular area will be able to identify specific tax issues that relate to transactions in area
  • get a good understanding of client’s facts
  • then combine your understanding of facts with your knowledge of tax law
  • initial response is (1)is item of expense deductible, (2)is item of income taxable, (3)what year should expense be deducted, (4)what year should item of income be taxed
  • identify more specific issues that ultimately determine the tax ramifications of transaction

Step 3: Locate Relevant Authorities

  • locate relevant authorities (code sections, regulations, court cases, revenue rulings) that address the tax issue
  • services can aid researcher in identifying relevant authorities – can be found on internet and offer flexibility to conduct research almost anywhere
  • annotated tax services: tax service arranged by code section; for each code section, an annotated service includes the code section; a listing of the code section history; copies of congressional committee reports that explain changes to the code section; a copy of all the regulations issued for the specific code section; the service’s unofficial explanation of the code section; and brief summaries (called annotations) of relevant court cases, revenue rulings, revenue procedures, and letter rulings that address issues specific to the code section
  • topical tax services: tax service arranged by subject (i.e. topic); for each topic, topical services identify tax issues that relate to each topic, and then explain and cite authorities relevant to the issue (code sections, regulations, court cases, revenue rulings, etc.)
  • beginning tax researchers often prefer topical services because easier to read
  • go directly to relevant portions of annotated or topical service
  • describe transaction in three to five words
  • ideal keyword search typically includes (1)relevant area of law and (2)fact or two that describes the transaction
  • try to avoid keywords that are too broad or that may be too narrow

Step 4: Analyze Tax Authorities

  • make sure that the authorities are still valid and up to date
  • question of fact: research question that hinges upon the facts and circumstances of the taxpayer’s transaction
  • which facts determine the answer
  • focus on understanding how various facts affect the research answer and identifying authorities with fact patterns
  • question of law: research question that hinges upon the interpretation of the law, such as interpreting a particular phrase in a code section
  • answer is clear with no opposing interpretations or contrary authorities
  • evaluate at hierarchical level, jurisdiction, and age of authorities, placing more weight on higher and newer authorities that have jurisdiction over taxpayer
  • tax researcher will become more adept at process as gain experience
  • citator: research tool that allows you to check the status of several types of tax authorities; will review the case to find out whether it was subsequently appealed and overturned and to identify subsequent cases that cite the case
  • favorable citations strengthen the case, unfavorable ones weaken it
  • check the Code – find most current version
  • checking regulations is a little more complicated

Step 5: Communicate the Results

  • most common end product of research question is internal research memo the researcher drafts for supervisor’s attention
  • 5 parts and written in objective manner by discussing all relevant authorities to research question, including authorities that support and conflict with answer

Facts

  • discuss facts relevant to question presented – provide necessary background of transaction and those facts that may influence research answer
  • keep discussion brief to focus reader’s attention on relevant characteristics of transaction

Issues

  • state specific issues that memo addresses
  • confirms understand research question, reminds reader of question being analyzed, allows future researchers to determine whether analysis in memo is relevant
  • should be written as specifically as possible and limited to one or two sentences per issue

Authorities

  • cites relevant tax authorities that apply to issue
  • consider authorities that support desired conclusion as well as those that may go against it

Conclusion

  • one conclusion per issue
  • conclusion should answer question as briefly as possible and indicated why answer is what it is

Analysis

  • provide reader with clear understanding of area of law and specific authorities that apply
  • organized to discuss the general areas of law first and then the specific authorities that apply to the research question
  • discuss as many as necessary to provide reader an understanding of issue and relevant authorities
  • apply authorities to client’s transaction and explain how authorities result in conclusion

Client Letters

  • tax professionals send clients letters that summarize their research and recommendations
  • basic components include (1) research question and limitations, (2) facts, (3) analysis, and (4) closing

Research Question Limitations

  • clearly state research question addressed and any disclaimers related to the work performed
  • ensures tax professional and client have mutual understanding of question researched and any limitations on research performed
  • issues should be written as specifically as possible and limited to one or two sentences

Facts

  • briefly summarize facts relevant to question presented – facts the provide necessary background of transaction and facts that may influence research answer
  • keep discussion brief to focus client’s attention on relevant characteristics of transaction

Analysis

  • summarize relevant authorities and their implications for client’s research question using precise language appropriate for client’s level of tax expertise
  • length of this portion will vary with complexity of research question and client’s interest in understanding specific research details

Closing

  • summarize key outcomes of research conducted and any recommended client action, thank client for requesting service, and remind client to contact you with additional questions or for further assistance

Tax Professional Responsibilities

  • tax practitioners are subject to variety of statutes, rules, and codes of professional conduct
  • Statements on Standards for Tax Services (SSTS): standards of practice for tax professionals issued by the AICPA
  • should absolutely have working knowledge of statutes, rules, and guidelines because (1) establish professional standards for practitioner and (2) failure to comply with standards could result in adverse consequences for tax professional (admonished, suspended, or barred from practicing before IRS)
  • CPAs are bound by Code of Professional Conduct and SSTS
  • importance of CPA maintaining independence from client and using due professional care in carrying out responsibilities
  • limit acceptance of contingent fees, preclude discreditable acts such as signing false return, prohibit false advertising and charging commissions
  • SSTS recommends appropriate standards of practice for tax professionals
  • encourage increased understanding by the Treasury, IRS, and public of a CPA’s professional standards
  • seven SSTS describe tax professional standards when:
  • recommending tax return position
  • answering questions on a tax return
  • preparing a tax return using data supplied by a client
  • using estimates on a tax return
  • taking a tax return position inconsistent with a previous year’s tax return
  • discovering a tax return error
  • giving tax advice to taxpayers
  • must comply with standards imposed by applicable tax authority when recommending tax return or preparing or signing a tax return (IRC Sec. 6694)
  • IRC Sec. 6694 imposes penalty on tax practitioner for any position that is not supported by substantial authority
  • substantial authority: standard used to determine whether a tax practitioner may recommend and a taxpayer may take a tax return position without being subject to IRS penalty under IRS Sec. 6694 and Sec. 6662
  • good tax professional evaluates whether supporting authority is substantial based on supporting and opposing authorities’ weight and relevance
  • taxpayer’s position is sustained upon audit or litigation is in 35 to 40% range or above
  • tax practitioner can avoid penalty under IRC Sec. 6694 if tax return position has at lease reasonable basis and position is disclosed on taxpayer’s return
  • Circular 230: issued by IRS, provides regulations governing tax practice and applies to all persons practicing before the IRS
  • 3 parts –
  • Subpart A describes who may practice before IRS (CPAs, attorneys, enrolled agents) and what practicing before the IRS means (tax return preparation, representing clients before IRS)
  • Subpart B describes duties and restrictions that apply to individuals governed by Circular 230 and include discussing submission of records to IRS, guidelines when tax return error, restrictions on charging contingency fees, prohibition of sharing employment with someone suspended, stringent rues relating to providing advice for tax shelters, and standards for when practitioner can recommend a tax return
  • Subpart C describes disciplinary proceedings for practitioners violating the Circular 230 provisions
  • good bit of overlap between Circular 230 and AICPA SSTS
  • IRC and other regulations contain requirements to tax professionals
  • keep abreast of all applicable guidance, regardless of specific authoritative source
  • only attorneys, CPAs, enrolled agents, and registered tax return preparers authorized to practice before IRS are eligible to receive PTIN (preparer tax identification number)
  • failure to include PTIN on returns is subject to $50 penalty per violation

Taxpayer and Tax Practitioner Penalties

  • IRS can impose penalties to encourage tax compliance by both tax professionals and taxpayers
  • civil penalties: much more common, generally come in form of monetary penalties, and may be imposed when tax practitioners or taxpayers violate tax statutes without reasonable cause (result of negligence, intentional disregard of pertinent rules, willful disobedience, outright fraud)
  • criminal penalties: much less common, have been used to incarcerate some of most notorious criminals; commonly charged in tax evasion cases, which include willful intent to defraud the government but imposed only after normal due process including a trial
  • standard of conviction is higher in criminal trial, guilt must be proven beyond a reasonable doubt
  • penalties are much higher (fines up to $100,000 and prison sentence)
  • taxpayer will have to pay interest on underpayment, will not be subject to underpayment penalty if there is substantial authority that supports the tax return position

Conclusion

  • fundamentals form basis for much of tax preparer’s work
  • tax research forms the basis of much of tax professional’s compliance and planning services
  • gaining a basic understanding of tax practice and procedure is important, as assisting clients with IRS audit process is valued service that accountants provide and clients expect all accountants to understand basic tax procedure issues and how to research basic tax issues

Summary

  • Identify the filing requirements for income tax returns and the statute of limitations for assessment.
  1. All corporations must file a tax return annually regardless of their taxable income. Estates and trusts are required to file annual income tax returns if their gross income exceeds $600.  The filing requirements for individual taxpayers depend on the taxpayer’s filing status, age, and gross income.
  2. Individual and partnership tax returns are due on the fifteenth day of the fourth month following year-end. For corporations, tax returns must be filed by the fifteenth day of the third month following the corporation’s fiscal year end.  Any taxpayer unable to file a tax return by the original due date can request an extension to file.
  • For both amended tax returns filed by a taxpayer and proposed tax assessments by the IRS, the statute of limitations generally ends three years from the later of (1) the date the tax return was actually filed or (2) the tax return’s original due date.
  • Outline the IRS audit process, how returns are selected, the different types of audits, and what happens after the audit.
  1. The IRS uses a number of computer programs and outside data sources to identify tax returns that may have an understated tax liability. Common computer initiatives include the DIF (Discriminant Function) system, document perfection program, and information matching program.
  2. The three types of IRS audits consist of correspondence, office, and field examinations.
  • After the audit, the IRS will send the taxpayer a 30-day letter, which provides the taxpayer the opportunity to pay the proposed assessment or request an appeals conference. If an agreement is not reached at appeals or the taxpayer does not pay the proposed assessment, the IRS will send the taxpayer a 90-day letter.  At this time, the taxpayer may pay the tax or petition the US Tax Court to hear the case.  If the taxpayer chooses to pay the tax, the taxpayer may then request a refund of the tax and eventually sue the IRS for a refund in the US District Court or the US Court of Federal Claims.
  • Evaluate the relative weights of the various tax law sources.
  1. Primary authorities are official sources of the tax law generated by the legislative branch (statutory authority issued by Congress), judicial branch (rulings by the US District Court, US Tax Court, US Court of Federal Claims, US Circuit Court of Appeals, or US Supreme Court), or executive/administrative brand (Treasury and IRS pronouncements). Secondary authorities are unofficial tax authorities that interpret and explain the primary authorities.
  • Describe the legislative process as it pertains to taxation.
  1. Exhibit 2-7 illustrates the legislative process for enacting tax law changes. Bills proceed from the House Ways and Means Committee to the House of Representatives.  If approved, the act is sent to the Senate Finance Committee with a revised version then sent to the US Senate.  If approved, the Joint Conference Committee considers the acts passed by the House of Representatives and Senate.  If a compromise is reached, the revised act is sent to the House of Representatives, if approved then to the Senate, and if approved then to the president.  If signed by the president, the act is incorporated into the IRC of 1986.  If the president vetoes the legislation, Congress may override the veto with a two-thirds positive vote in both the House of Representatives and Senate.
  • Perform the basic steps in tax research and evaluate various tax law sources when faced with ambiguous statutes.
  1. The five basic steps in tax research are (1) understand the facts, (2) identify issues, (3) locate relevant authorities, (4) analyze the tax authorities, and (5) communicate research results.
  2. When the researcher identifies that different authorities have conflicting views, she should evaluate the “hierarchy,” jurisdiction, and age of the authorities, placing more weight on higher and newer authorities that have jurisdiction over the taxpayer.
  • Describe tax professional responsibilities in providing tax advice.
  1. Tax practitioners are subject to a variety of statues, rules, and codes of professional conduct. Some examples include the American Institute of CPAs (AICPA) Code of Professional Conduct, the AICPA Statements on Standards for Tax Services (SSTS), the IRS’s Circular 230, and statutes enacted by a CPA’s specific state board of accountancy.
  2. The AICPA’s Statements on Standards for Tax Services (SSTS) recommend appropriate standards of practice for tax professionals. Many state boards of accountancy have adopted similar standards, thus making the SSTS especially important.  Currently, there are seven SSTS summarized in Exhibit 2-11 that describe the tax professional standards.
  • Circular 230 provides regulations governing tax practice and applies to all persons practicing before the IRS. There is a good bit of overlap between Circular 230 and the AICPA SSTS.
  • Identify taxpayer and tax professional penalties.
  1. The IRS can impose both criminal and civil penalties to encourage tax compliance by both tax professionals and taxpayers. Civil penalties are much more common, generally come in the form of monetary penalties, and may be imposed when tax practitioners or taxpayers violate tax statutes without reasonable cause.  Some common examples of civil penalties are listed in Exhibit 2-12.
  2. Criminal penalties are much less common than civil penalties and are commonly charged in tax evasion cases. Compared to civil cases, the standard of conviction is higher in a criminal trial, but the penalties are also much higher.
  • A taxpayer will not be subject to an underpayment penalty if there is substantial authority that supports the tax return position.
  1. A tax practitioner will also not be subject to penalty for recommending a tax return position if there is substantial authority that supports the position.
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