Prentice Hall's Federal Taxation 2011: Corporations, 24e (Pope) Chapter 15 Administrative Procedures

1) The majority of the individual tax returns that are audited are selected under the DIF program. Answer FA!"#
$age %ef. & 1'('

)) The I%" will issue a *+(day letter ,a "tatutory -otice of Deficiency) if the taxpayer does not file a protest letter within .+ days of the date of the .+(day letter. Answer T%/#
$age %ef. & 1'(0

.) The *+(day letter ,"tatutory -otice of Deficiency) gives the taxpayer *+ days to file a petition with Tax &ourt or to pay the disputed tax. Answer T%/#
$age %ef. & 1'(0

1) If the taxpayer has credi2le evidence3 the I%" 2ears the 2urden of proof in a tax dispute. Answer T%/#
$age %ef. & 1'(1+

') A letter ruling is a written determination that interprets and applies the tax laws to the taxpayer4s specific set of facts. Answer T%/#
$age %ef. & 1'(11

5) The 6automatic6 extension period for filing an individual return is seven months. Answer FA!"#
$age %ef. & 1'(1.

7) The maximum failure to file penalty is a total of )'8 of the underpayment. Answer T%/#
$age %ef. & 1'(10

0) A taxpayer who fails to file and fails to pay taxes is su2ject to a com2ined '. '8 monthly penalty on the underpayment. Answer FA!"#
$age %ef. & 1'(10

*) The statute of limitations3 which stipulates the time frame within which either the government or the taxpayer may re9uest a redetermination of tax due3 usually expires 5 years after the date on which the return is filed. Answer FA!"#
$age %ef. & 1'()5

1+) The statute of limitations is unlimited for a tax return that is never filed. Answer T%/#
$age %ef. & 1'()7

1 Copyright 2011 Pearson Education, Inc.

11) Treasury Department &ircular ).+ regulates the practice of attorneys3 &$As3 enrolled agents3 and enrolled actuaries 2efore the I%". Answer T%/#
$age %ef. & 1'(..

1)) Anyone who prepares a tax return is su2ject to the provisions of &ircular ).+. Answer FA!"#
$age %ef. & 1'(..

1.) The Internal %evenue "ervice is part of the A) &ongress. :) Treasury Department. &) Federal :ureau of Investigation. D) /.". &ustoms Department. Answer :
$age %ef. & 1'()

11) The program specifically designed to identify returns with a high potential for a deficiency assessment is the A) T&;$. :) DIF program. &) Instant audit program. D) 1+1+ program. Answer :
$age %ef. & 1'('

1') Identify which of the following statements is false. A) The majority of the individual tax returns that are audited are selected under the DIF program. :) The T&;$ audit program has 2een temporarily suspended 2y the I%" and replaced in part 2y lifestyle audits. &) The I%" is authori<ed to pay a reward to individuals who provide information resulting in increased collections. D) All are false. Answer A
$age %ef. & 1'(1(& 1'(5

15) Identify which of the following statements is true. A) If a taxpayer has 2een audited in at least one of the two previous years on the same item and the earlier audit did not result in any additional tax owed3 the taxpayer may 9ualify for the special audit relief rule. :) A taxpayer can re9uest and always receive an exemption from an audit 2y the I%" if his return was audited in at least one of the two previous years and the previous audit did not result in any change to his tax lia2ility. &) The signing of Form 07+ allows the taxpayer to wait for .+ interest(free days after the 2illing date to pay the tax. D) All are true. Answer A
$age %ef. & 1'(7

2 Copyright 2011 Pearson Education, Inc.

17) Identify which of the following statements is false. A) A Technical Advice ;emorandum may 2e re9uested 2y an I%" auditor if the transaction in 9uestion involves an especially complex tax issue. :) If the taxpayer 2eing audited does not concur with the proposed assessment3 the "ervice is re9uired to send the taxpayer a .+(day letter detailing the proposed changes and the availa2le appeals process. &) During the audit process3 if the taxpayer concurs with the assessment of tax 2y the I%" and signs Form 07+ ,=aiver of "tatutory -otice)3 then the taxpayer is precluded from filing a refund suit. D) Interest on a deficiency accrues from the due date of the return through the payment date. Answer &
$age %ef. & 1'(03 & 1'(*

10) Identify which of the following statements is false. A) Appeals officers usually have the operating authority to settle disputes with taxpayers 2ased on the 6ha<ards of litigation6. :) =hen an appeals officer is dealing with an 6appeals coordinated issue63 he has the authority to settle with the taxpayer 2ased on the 6ha<ards of litigation.6 &) A Technical Advise ;emorandum may 2e re9uested 2y an I%" auditor if the transaction in 9uestion involves an especially complex tax issue. D) If the taxpayer and the appeals officer fail to reach agreement3 the I%" issues a *+(day letter. Answer :
$age %ef. & 1'(03 & 1'(*

1*) The I%" provides advice concerning an issue that arises during an audit 2y issuing A) a revenue ruling. :) an audit memorandum. &) a technical advice memorandum. D) a private letter ruling. Answer &
$age %ef. & 1'(0

)+) In order to appeal to the Appeals Division3 a taxpayer must su2mit a protest letter to the I%" A) if an office audit is involved. :) as a response to receiving a .+(day letter. &) in a field audit involving a assessment of taxes3 interest3 and penalties in excess of >1+3+++. D) if a T&;$ audit is involved. Answer &
$age %ef. & 1'(0

)1) A taxpayer will receive a .+(day letter A) to notify him that the return was selected for audit. :) after a response to the *+(day letter with a protest. &) only if the taxpayer does not sign Form 07+. D) only if the taxpayer is more than .+ days late in filing the tax return. Answer &
$age %ef. & 1'(0

3 Copyright 2011 Pearson Education, Inc.

))) ?ow long does a taxpayer have to file a petition with the /.". Tax &ourt following the date of the "tatutory -otice of Deficiency@ A) *+ days :) three months &) 10+ days D) .+ days Answer A
$age %ef. & 1'(*

).) The court in which the taxpayer does not have to pay the tax and then litigate for a refund is the A) /.". &ourt of Federal &laims. :) Federal district court. &) Tax &ourt. D) all of the a2ove Answer &
$age %ef. & 1'(*

)1) Identify which of the following statements is true. A) Form 07+(AD is used if the taxpayer and I%" representative agree to a lesser tax lia2ility than that originally proposed 2y the "ervice. :) "igning of Form 07+(AD 2y the taxpayer does not generally preclude the su2se9uent filing of a refund claim. &) The I%" will issue a *+(day letter ,a "tatutory -otice of Deficiency) if the taxpayer does not file a protest letter within 1+ days of the date of the .+(day letter. D) All are false. Answer A
$age %ef. & 1'(*

)') Identify which of the following statements is true. A) The *+(day letter offers the taxpayer the choice of paying the tax assessed or filing a petition refuting the tax assessment with the Tax &ourt. :) A taxpayer can choose to initiate tax litigation in a /.". district court3 the Tax &ourt or a &ourt of Appeals. &) The I%" cannot raise a new tax issue after issuance of the "tatutory -otice of Deficiency ,*+(day letter). D) All are false. Answer A
$age %ef. & 1'(*

)5) Identify which of the following statements is false. A) In general3 the taxpayer has the 2urden of proof in Tax &ourt cases. ?owever3 the I%" has the 2urden of proof for issues raised after the issuance of the *+(day letter. :) A taxpayer may want to avoid using the Tax &ourt to litigate an issue 2ecause decisions from this court cannot 2e appealed. &) The Tax &ourt can 2e used to litigate a tax issue without first paying the tax assessment. D) In order to litigate in the Tax &ourt3 a petition must 2e filed within *+ days of the issuance of a notice of deficiency. Answer :
$age %ef. & 1'(*

4 Copyright 2011 Pearson Education, Inc.

)7) Identify which of the following statements is false. A) If the phrase3 6#ntered under %ule 1''6 appears at the end of the Tax &ourt4s opinion3 the litigating parties must jointly determine the additional tax due. :) A taxpayer does not have to pay the tax assessment 2efore filing suit in a /.". district court or the /.". &ourt of Federal &laims. &) #ither the taxpayer or the government can appeal the decision of a court of original jurisdiction to the next higher court with the potential for a final ruling from the /.". "upreme &ourt if a writ of certiorari is granted. D) All are false. Answer :
$age %ef. & 1'(*

)0) Identify which of the following statements is false. A) "o called private letter rulings are made pu2lic after confidential information is eliminated. :) A letter ruling is a written statement issued to a taxpayer 2y the I%" that interprets and applies the tax laws to that taxpayer4s specific set of facts. &) Anly the taxpayer can appeal the decision of a court of original jurisdiction to the next higher court. D) If the "upreme &ourt decides to hear a case it grants certiorari. Answer &
$age %ef. & 1'(*3 & 1'(1+

)*) =hich one of the following statements a2out letter rulings is false@ A) If a taxpayer re9uests and pays for a ruling3 the I%" must respond to his re9uest 2y issuing a ruling. :) A ruling is a response to a taxpayer4s specific set of facts. &) %ulings 2ecome pu2lic information. D) The I%" issues revenue procedures periodically which prescri2e the information that must 2e supplied with a ruling re9uest. Answer A
$age %ef. & 1'(11(& 1'(1)

.+) =hich of the following items can 2e omitted from a taxpayer4s re9uest for a ruling@ A) -ames3 addresses3 and taxpayer identification num2ers of all interested parties. :) A detailed explanation of the transaction. &) The particular conclusion desired 2y the taxpayer. D) The location of the I%" district office that has examination jurisdiction. Answer &
$age %ef. & 1'(11

.1) The I%" will issue a ruling A) on prospective transactions only. :) only if regulations have 2een issued on the su2ject. &) on a completed transaction for which a return has 2een filed. D) to clarify the tax treatment of a transaction. Answer D
$age %ef. & 1'(11

5 Copyright 2011 Pearson Education, Inc.

.)) Identify which of the following statements is false. A) The I%" issues annually a revenue procedure that prescri2es how a letter ruling should 2e re9uested and the information to 2e contained in the ruling re9uest. :) The re9uest for a ruling may contain a suggested conclusion ,or answer) that the taxpayer proposes that the I%" adopt in the descri2ed situation. &) As a practical consideration3 taxpayers always find it prefera2le to o2tain an advance ruling on 9uestiona2le tax situations. D) Third parties may not cite private letter rulings as authority for the tax conse9uences of their transactions. Answer &
$age %ef. & 1'(1+(& 1'(1)

..) Identify which of the following statements is false. A) The I%" will not issue a ruling on the topic of whether compensation is reasona2le. :) Tax returns for all taxpayers must 2e filed on or 2efore the fifteenth day of the fourth month following the year(end. &) A corporation must file a tax return even if it has no gross income. D) #xtensions of time for filing tax returns may 2e o2tained. Answer :
$age %ef. & 1'(1)

.1) Identify which of the following statements is true. A) A partnership is not re9uired to file a return if the partnership has no income for the year. :) The 6automatic6 extension period for filing an individual return is five months. &) Individuals and corporations may o2tain 5(month extensions for paying taxes and filing their returns for the taxa2le year 2y filing the appropriate extension re9uests. D) All are false. Answer &
$age %ef. & 1'(1)3 & 1'(1.

.') An automatic extension of time from the regular filing date for an individual tax return may 2e received3 without giving the I%" a reason3 for A) ) months. :) . months. &) 1 months. D) 5 months. Answer D
$age %ef. & 1'(1.

.5) If a return4s due date is extended3 a taxpayer A) also extends the period in which to pay taxes without interest. :) still should pay the tax 2y the original return due date. &) has .+ days following the original due date to pay estimated taxes without penalty. D) has .+ days following the original due date to pay estimated taxes without interest. Answer :
$age %ef. & 1'(1.

6 Copyright 2011 Pearson Education, Inc.

.7) In which of the situations 2elow will a taxpayer not 2e assessed interest on the tax remitted@ A) An extension is o2tained and the tax is paid within the extension period. :) A timely return is filed 2ut the taxpayer must delay payment of the taxes. &) The return is audited and additional tax is owed. D) none of the a2ove Answer D
$age %ef. & 1'(11

.0) Identify which of the following statements is false. A) Interest is imposed on any tax not paid 2y the due date of the return ,determined without regard to extensions). :) Interest is charged on underpayments3 or paid on overpayments3 at a rate of three percentage points higher than the federal short(term rate. &) Interest on underpayments is calculated using daily compounding and covers a time period from the original due date of the return until the date of payment. D) Any tax not paid 2y the due date for the return is su2ject to an interest charge. Answer :
$age %ef. & 1'(11

.*) Identify which of the following statements is false. A) In addition to interest3 taxpayers may 2e su2ject to penalties for failure to file on time and failure to pay taxes 2y the due date for the return. :) The failure(to(file penalty is levied against taxpayers who do not file a return 2y its due date at a rate of '8 per month ,or fraction of a month) with a maximum additional penalty of )'8. &) The failure(to(pay penalty is imposed at a rate of '8 per month ,or fraction of a month) with a maximum penalty of )'8. D) A different interest rate is charged to corporate and noncorporate taxpayers. Answer &
$age %ef. & 1'(17

1+) A calendar(year individual taxpayer files last year4s income tax return on Acto2er 17 of the current year. -o extension was re9uested3 and there is not a reasona2le cause for the late filing. The return shows a 2alance due of >13'++ of tax. The late filing penalty is A) >+. :) >7'. &) >.7'. D) >1'+. Answer & #xplanation &) The penalty is '8 per month ,or fraction thereof) with a maximum of )'8. ?ere the maximum applies. +.)' B >13'++ C >.7'
$age %ef. & 1'(17

7 Copyright 2011 Pearson Education, Inc.

11) A calendar(year individual taxpayer files last year4s income tax return on Duly 1 of the current year. -o extension was re9uested3 and there is not a reasona2le cause for the late filing. The return shows a 2alance due of >0++ of tax. The late filing penalty is A) >+. :) >1+. &) >0+. D) >1)+ Answer D #xplanation D) The penalty is '8 per month ,or fraction thereof). +.+' B . months B >0++ C >1)+
$age %ef. & 1'(17

1)) Eerald re9uests an extension for filing his last year4s individual income tax return. ?is tax lia2ility is >1+3+++3 of which >03+++ was withheld leaving a 2alance due of >)3+++ when he files on August 1 of the current year. ?is penalty for failure to pay the tax on time is A) >+. :) >1+. &) >.++. D) >1++. Answer : #xplanation :) .++' B 1 months B >)3+++ C >1+
$age %ef. & 1'(10

1.) If :rad files his last year4s individual tax return on Duly ' of the current year after having re9uested an extension3 what is the amount of his failure(to(pay penalty if his total tax is >1+3+++ and he paid >*3'++ through timely withholding and >'++ with the return@ A) >+ :) >5 &) >5+ D) none of the a2ove Answer A #xplanation A) ?is 2alance due is >'++3 which is not more than 1+8 of his total tax of >1+ 3 +++. There is no penalty
$age %ef. & 1'(10

11) Identify which of the following statements is true. A) The failure(to(pay penalty is waived if the additional tax due with the filing of the extended return does not exceed 1'8 of the tax owed for the year. :) If 2oth the failure(to(file and the failure(to(pay penalties are owed3 the taxpayer will incur a maximum addition to tax of '. '8 per month. &) Individuals having su2stantial income from sources not su2ject to regular withholding generally should maFe 9uarterly estimated tax payments to the I%". D) All are false. Answer &
$age %ef. & 1'(1*

Copyright 2011 Pearson Education, Inc.

1') Gour client wants to avoid any penalty for underpayment of estimated taxes 2y maFing timely deposits. Determine the amount of the minimum 9uarterly estimated tax payments re9uired to avoid the penalty. Assume your client4s adjusted gross income last year was >11+3+++. !ast year4s tax lia2ility >1+3+++ This year4s estimated total tax 113+++ Taxes to 2e withheld for this year *3+++ A) >735'+ :) >737'+ &) >037'+ D) >113+++ Answer A #xplanation A) /se the lesser of *+8 of this year4s tax or 1++8 of last year4s tax. >113+++ B +.*+ >.*35++ , *3+++) >.+35++ B +.)' > 735'+ #stimated current year tax lia2ility Times ;inimum payment re9uirement %e9uired payment ;inus =ithholding Amount to 2e paid via estimated tax payments Huarterly re9uired estimated tax payment

This amount is less than )'8 of last year4s tax lia2ility ,>1+3+++) minus the amount withheld ,>*3+++)3 or >737'+
$age %ef. & 1'(1*3 & 1'()+

15) A taxpayer can automatically escape the penalty for underpayment of taxes 2y A) owing less than >13+++ in taxes over and a2ove the taxes withheld from wages. :) owing taxes in the previous year. &) having a casualty loss. D) none of the a2ove Answer A
$age %ef. & 1'()1

17) A taxpayer4s return is audited and additional taxes are assessed. The I%" also asserts that a negligence penalty should 2e assessed. The taxpayer concurs with the additional >1'3+++ tax lia2ilityI >73+++ of this amount is attri2uta2le to negligence. =hat is the amount of the penalty for negligence@ A) >7++ :) >131++ &) >'35++ D) >137'+ Answer : #xplanation :) +.)+ B >73+++ C >131++
$age %ef. & 1'())I #xample & 1'()+

! Copyright 2011 Pearson Education, Inc.

10) A su2stantial understatement of tax lia2ility involves which of the following@ A) /nderstatement of tax exceeding the greater of 1+8 of tax re9uired to 2e shown on the return or >'3+++ for individuals. :) /nderpayment of tax exceeding the greater of 1'8 of the tax re9uired to 2e shown on the return or >'3+++ for individuals. &) /nderpayment of tax exceeding the lesser of )'8 of the tax re9uired to 2e shown on the return or >'3+++ for individuals. D) >1+3+++ or more difference 2etween the amount shown on the return and the correct amount due. Answer A
$age %ef. & 1'().

1*) =hich of the following is not a reason for relief from the su2stantial understatement penalty@ A) Disclosure of the relevant facts pertaining to the 9uestiona2le tax return position. :) "u2stantial authority for the tax return position. &) %eliance on a tax return preparer. D) %easona2le cause and a good faith effort to comply with the tax law. Answer &
$age %ef. & 1'().

'+) =hat is the re9uirement for a su2stantial understatement of tax for individuals@ A) The understatement exceeds 1+8 of the tax re9uired to 2e shown on the return. :) The understatement exceeds >'3+++. &) The understatement exceeds the lesser of 1+8 of the tax re9uired to 2e shown on the return or >'3+++. D) The understatement exceeds the greater of 1+8 of the tax re9uired to 2e shown on the return or >'3+++. Answer D
$age %ef. & 1'().

'1) Identify which of the following statements is true. A) An individual taxpayer may 2e su2ject to a penalty for underpayment of estimated taxes if his 2alance of tax due when he files is >'++. :) A penalty for su2stantial understatement will potentially 2e assessed on an individual if the underpayment of tax exceeds the greater of 1'8 of the tax shown on the return or >'3+++. &) "u2stantial authority exists for a position that is supported 2y a decision rendered 2y the &ourt of Appeals for the taxpayer4s own circuit. D) All are true. Answer &
$age %ef. & 1'()1

')) Identify which of the following statements is false. A) If fraud is asserted in a tax transaction3 the 2urden of proof falls on the I%". :) The civil fraud penalty consists of 7'8 of the tax underpayment attri2uta2le to fraud plus )'8 of the interest paya2le on the portion of the underpayment resulting from the fraud. &) The Eovernment must prove its case 62eyond a reasona2le dou2t6 in order for the court or jury to convict a taxpayer of criminal fraud. D) The fraud penalty can 2e imposed with respect to income3 gift and estate tax returns. Answer :
$age %ef. & 1'()1

10 Copyright 2011 Pearson Education, Inc.

'.) A six(year statute of limitation rule applies if the taxpayer A) understates taxa2le income 2y )'8. :) understates AEI 2y )'8. &) understates gross income 2y )'8. D) none of the a2ove Answer &
$age %ef. & 1'()5

'1) An April 1'3 )++*3 a married couple filed their joint )++0 tax return showing gross income of >1)+3+++. Their return was prepared 2y a professional tax preparer who mistaFenly omitted >1'3+++ of income3 which the preparer in good faith considered to 2e nontaxa2le. -o information with regard to this omitted income was disclosed on the return or attached statements. :y what date must the I%" assert a notice of deficiency 2efore the statute of limitations expires@ A) April 1'3 )+1' :) Decem2er .13 )+11 &) April 1'3 )++* D) Decem2er .13 )++* Answer A
$age %ef. & 1'()5

'') Identify which of the following statements is true. A) The statute of limitations3 which stipulates the time frame within which either the government or the taxpayer may re9uest a redetermination of tax due3 usually expires 5 years after the date on which the return is filed. :) The statute of limitations limits the time during which a taxpayer may claim a refund of an overpayment of tax. &) If a taxpayer omits from gross income an amount in excess of )'8 of the gross income shown on his return3 the statute of limitations is five years. D) All are true. Answer :
$age %ef. & 1'()5

'5) Terry files his return on ;arch .1. The return shows taxes of >53+++3 and Terry pays this entire amount when he files his return. :y what time must he file a claim of refund@ A) The later of two years from the return filing or three years from the date the tax is paid. :) The later of three years from the return due date or two years from the date the tax is paid. &) Two years from the payment of tax date3 if the I%" mails a notice of deficiency in the third year following the due date of the return. D) Four years from the payment of tax date3 if the I%" mails a notice of deficiency. Answer :
$age %ef. & 1'()*

11 Copyright 2011 Pearson Education, Inc.

'7) "teve files his return on April 1 and pays the entire amount of tax for the year at that time3 >'3+++. ?e is audited and pays the deficiency of >13'++ two years later. The maximum amount "teve may file a claim for refund for eighteen months later is A) >53'++. :) >'3+++. &) >13'++. D) some other amount. Answer &
$age %ef. & 1'()*

'0) Identify which of the following statements is true. A) If a taxpayer fails to file a return3 the statute of limitations is extended to 1+ years. :) If a couple files a joint return 2ut only one spouse had income3 only the spouse with income is responsi2le for paying any tax due. &) Doint and several lia2ility means that each spouse is potentially lia2le for the full amount of tax due. D) All are false. Answer &
$age %ef. & 1'(.+

'*) The innocent spouse relief provision from tax lia2ility covers all of the following except A) improper deductions. :) improper credits. &) improper 2asis. D) all are understatements su2ject to minimum thresholds. Answer D
$age %ef. & 1'(.+

5+) All of the following re9uirements must 2e met in order to esta2lish innocent spouse relief3 except A) The return contains an understatement of tax attri2uta2le to the erroneous item,s) of an individual filing it. :) The re9uest for innocent spouse relief no later than one year after the I%" 2egins its collection efforts. &) The re9uesting individual esta2lishes that he or she neither Fnew nor had reason to Fnow of any or all of the understatement. D) :ased on all the facts and circumstances3 holding the other individual for the deficiency would 2e ine9uita2le. Answer :
$age %ef. & 1'(.+

51) Tax return preparers can 2e penali<ed for the following activities3 except A) failure to sign a return. :) failure to give a copy of the return to the taxpayer. &) failure to maintain I%" continuing education re9uirements. D) failure to provide the preparer4s identification num2er on the return. Answer &
$age %ef. & 1'(.1

12 Copyright 2011 Pearson Education, Inc.

5)) =hat is the penalty for a tax return preparer who willfully attempts to understate taxes3 or intentionally disregards the tax rules and regulations@ A) >'+. :) >)'+. &) the greater of >'3+++ or '+8 of the income derived from the return D) )+8 of the understatement. Answer &
$age %ef. & 1'(.)

5.) =hat is the penalty for a tax return preparer who taFes a tax return position that does not have a realistic possi2ility of success of 2eing sustained on its own merits@ A) >'+. :) >)'+. &) >13+++ D) )+8 of the understatement. Answer &
$age %ef. & 1'(.1

51) =hat is the I%" guideline for determining whether a tax return position has a realistic possi2ility of success of 2eing sustained on its own merits@ A) A person Fnowledgea2le in the tax law concludes that the position has at least a one(in( three liFelihood of 2eing supported. :) A person Fnowledgea2le in the tax law concludes that the position has at least a '+8 liFelihood of 2eing supported. &) A person Fnowledgea2le in the tax law concludes that the position has at least a two( thirds liFelihood of 2eing supported. D) A person Fnowledgea2le in the tax law concludes that the position has at least a 7'8 liFelihood of 2eing supported. Answer A
$age %ef. & 1'(.'

5') Identify which of the following statements is true. A) The 6innocent spouse provision36 if applica2le3 relieves 2oth spouses from an assessment of tax caused 2y a spouse4s understating income or gain andJor overstating deductions3 losses3 or credits. :) The I%" is precluded from assessing any residual tax lia2ility against transferees and fiduciaries 2ecause the initial filers are responsi2le for meeting the tax payments in a timely fashion. &) Treasury Department &ircular ).+ regulates the practice of attorneys3 &$As3 enrolled agents3 and enrolled actuaries 2efore the I%". D) All are false. Answer &
$age %ef. & 1'(..

13 Copyright 2011 Pearson Education, Inc.

55) According to &ircular ).+3 what should a &$A do upon discovery of an error in a client4s prior year return@ A) -otify the I%" of the error. :) Inform the client of the error and its tax conse9uences. &) File an amended return for the client. D) Do nothing. Answer :
$age %ef. & 1'(..

57) =hich of the following statements regarding &ircular ).+ is false@ A) &ircular ).+ applies to all tax return preparers. :) &ircular ).+ defines practice 2efore the I%". &) &ircular ).+ provides guidance as to the level of authority necessary for a &$A to taFe a tax return position. D) &ircular ).+ applies to &$As3 enrolled agents3 enrolled actuaries and attorneys. Answer A
$age %ef. & 1'(..

50) The 6"tatement on $ractice in the Field of Federal Income Taxation6 includes all of the following areas of mutual competence except A) preparing federal income tax returns. :) determining the tax effect of proposed transactions. &) representing clients in criminal investigations. D) representing taxpayers 2efore the /.". Tax &ourt. Answer &
$age %ef. & 1'(.7

5*) =hich of the following activities are protected 2y accountant(client privilege@ A) written communications 2etween a &$A and a corporation regarding a tax shelter :) communications related to tax return preparation &) communications related to criminal tax evasion D) advice given regarding tax issues in a divorce Answer D
$age %ef. & 1'(.0

7+) =hich3 if any3 of the following could result in penalties against an income tax return preparer@ I. Knowing or recFless disclosure or use of tax information o2tained in preparing a return. II. A willful attempt to understate any client4s tax lia2ility on a return or claim for a refund. A) neither I nor II :) I only &) II only D) 2oth I and II Answer D
$age %ef. & 1'(.'

14 Copyright 2011 Pearson Education, Inc.

71) An August 1. of the following year3 Doy files her current calendar year tax return and pays the amount due without having re9uested an extension. The tax shown on her return is >)'3+++. ?er current year withholding tax is >1'3+++. Doy pays no estimated taxes and does not claim any tax credits on her current year return. &alculate the penalties that the I%" is liFely to assess. Ignore the penalty for underpayment of estimated taxes. Assume she did not commit fraud. Answer Failure(to(pay penalty(( .++' B ,>)'3+++ ( >1'3+++) B 1 months >)++ Failure(to(file penalty(( .+' B ,>)'3+++ ( >1'3+++) B 1 months >)3+++ ;inus Failure(to(pay penalty , )++) 130++ Total penalties >)3+++
$age %ef. & 1'(1'3 & 1'(1*

7)) An August 1. of the following year3 Doy files her current calendar year tax return and pays the amount due without having re9uested an extension. The tax shown on her return is >)'3+++. ?er current year withholding tax is >1'3+++. Doy pays no estimated taxes and does not claim any tax credits on her current year return. =ill Doy owe interest3 if so3 on what amount and for how many days@ Answer Amy owes interest on >'3+++ from April 15 of the current year through August 1. of the following year or for 1)+ days.
$age %ef. & 1'(113 & 1'(1'

7.) An Duly )' of the following year3 Doy files her current calendar year tax return. "he had re9uested extensions as re9uired. An Acto2er 03 she pays the amount due. The tax shown on her return is >))3+++. ?er current year withholding tax is >)13+++. Doy pays no estimated taxes and does not claim any tax credits on her current year return. &alculate the penalties that the I%" is liFely to assess. Ignore the penalty for underpayment of estimated taxes. Assume she did not commit fraud. Answer If Doy re9uests an extension3 the failure(to(file penalty will not apply 2ecause she files the return 2efore the August 1' extended due date. The failure(to(pay penalty is not imposed 2ecause the additional tax due with the filing of the return ,>13+++) does not exceed >)3)++3 or 1+8 of the >))3+++ tax owed for the year ,%eg. "ec. .+1. 55'1(1,c),.)).
$age %ef. & 1'(1'(& 1'(1*

71) An Duly )' of the following year3 Doy files her current calendar year tax return without having re9uested an extension. An Acto2er 03 she pays the amount due. The tax shown on her return is >)'3+++. ?er current year withholding tax is >)+3+++. Doy pays no estimated taxes and does not claim any tax credits on her current year return. Assume she did not commit fraud. =ill Doy owe interest3 if so3 on what amount and for how many days@ Answer Doy owes interest on >'3+++ from April 15 of the current year through Acto2er 0 of the following year or for 175 days.
$age %ef. & 1'(11

15 Copyright 2011 Pearson Education, Inc.

7') The taxes shown on Kate4s tax returns for )++0 and )++* were >53+++ and >*3+++ respectively. Kate4s withholding tax for )++* was >73+++ and she paid no estimated taxes. Kate filed her )++* return on April .3 )+1+3 2ut she did not have sufficient funds to pay the 2alance due. "he pays the >)3+++ 2alance due on Dune 1*3 )+11. Kate4s AEI for )++* did not exceed >1'+3+++. &alculate the penalties Kate owes on her )++* tax return. Answer Kate4s )++* AEI did not exceed >1'+3+++. Therefore3 she does not owe the penalty for underpaying estimated tax in )++* 2ecause she paid in an amount e9ual to her )++0 tax lia2ility. "he does not owe the failure(to(file penalty 2ecause she filed a timely return. "he owes the failure(to(pay penalty for 1' months. The penalty is >1'+ ,. ++' B >)3+++ B 1').
$age %ef. & 1'(17(& 1'(1*

75) $ete4s reported a tax lia2ility of >.3'++ on his )++* tax return. ?is )++* withholding was >.30++. ?e did not file his )++* return until Dune 1)3 )+1+. =hat penalties does $ete owe@ Answer $ete owes no penalty for failure(to(file or failure(to(pay 2ecause the amount withheld exceeds the tax lia2ility owed.
$age %ef. & 1'(17(& 1'(1*

77) !ucy files her current year individual income tax return on August ' of the following year3 without having re9uested an extension. ?er total tax is >1+3+++. !ucy pays >73'++ in a timely manner and the >)3'++ 2alance when she files the return. !ucy did not engage in fraud and has no reasona2le cause for late filing and late payment. &ompute !ucy4s penalties. Answer Failure(to(pay penalty >)3'++ B .++' B 1 months > '+ Failure(to(file penalty >)3'++ B .+' B 1 months 1++ !ess %eduction for failure(to(pay penalty for same period , '+) Total penalties >1++
$age %ef. & 1'(1*I #xample & 1'(11

70) An Duly )' of the following year3 Doy files her current calendar year tax return without having re9uested an extension. An Acto2er 03 she pays the amount due. The tax shown on her return is >)'3+++. ?er current year withholding tax is >)+3+++. Doy pays no estimated taxes and does not claim any tax credits on her current year return. &alculate the penalties that the I%" is liFely to assess. Ignore the penalty for underpayment of estimated taxes. Assume she did not commit fraud. Answer Failure(to(pay penalty(( .++' B ,>)'3+++ ( >)+3+++) B 5 months > 1'+ Failure(to(file penalty(( .+' B ,>)'3+++ ( >)+3+++) B 1 months >13+++ ;inus Failure(to(pay penalty for 1 months , 1++) *++ Total penalties >13+'+
$age %ef. & 1'(1*I #xample & 1'(1'

16 Copyright 2011 Pearson Education, Inc.

7*) :illy3 a calendar year taxpayer3 files his current year individual tax return on August 17 of the following year without having re9uested an extension. ?is return reports an amount due of >'3+++. :illy pays this amount on -ovem2er ). of the following year. =hat are :illy4s penalties for his failure to file and his failure to pay his tax on time@ Assume :illy did not commit fraud. Answer Failure(to(pay penalty(( .++' B >'3+++ B 0 months > )++ Failure(to(file penalty(( .+' B >'3+++ B ' months >13)'+ ;inus Failure(to(pay penalty for same time period (( . ++' B >'3+++ B ' months , 1)') 131)' Total penalties >13.)'
$age %ef. & 1'(1*I #xample & 1'(1'

0+) $aul4s tax lia2ility for last year was >.+3+++. $aul projects that his tax for this year will 2e >1+3+++. $aul is self(employed and3 thus3 will have no withholding. ?is AEI for last year did not exceed >1'+3+++. ?ow much estimated tax should $aul pay for this year to avoid the penalty for underpayment of estimated taxes@ Answer :ecause $aul4s AEI for last year does not exceed >1'+3+++3 he should pay in >.+3+++ ,1++8 of the prior year lia2ility)3 at a minimum3 to avoid the penalty.
$age %ef. & 1'(17(& 1'()+

01) Deff4s tax lia2ility for last year was >.+3+++. Deff projects that his tax for this year will 2e only >)'3+++. Deff is self(employed and3 thus3 will have no withholding. ?is AEI for last year did not exceed >1'+3+++. ?ow much estimated tax3 at a minimum3 should Deff pay for this year to avoid the penalty for underpayment of estimated taxes@ ?ow would your answer change if his income exceeded last year4s due to a large capital gain at the end of the year@ Answer Deff4s AEI for last year does not exceed >1'+3+++. Therefore3 he should pay in >))3'++ ,+.*+ B >)'3+++) 2ecause this amount is less than his last year4s tax lia2ility. A pro2lem arises3 however3 2ecause the large gain causes his actual tax for this year to exceed >)'3+++. If he pays in only >))3'++3 he will owe a penalty for underpayment of estimated taxes.
$age %ef. & 1'(17(& 1'()+

0)) !inda4s individual tax return for the current year is su2ject to an I%" audit. The I%" assesses a >1+3+++ deficiency3 >13+++ of which is due to !inda4s negligence. =hat is !inda4s negligence penalty@ Answer The negligence penalty is >0++ ,+.)+ B >13+++)3 the portion of the deficiency attri2uta2le to negligence.
$age %ef. & 1'())

0.) The I%" audits Kiara4s current year individual return and determines that3 among other errors3 she negligently did not report dividend income of >1+3+++. The deficiency with respect to the dividends is >)30++. The I%" argues for an additional >1)3+++ deficiency for various other errors that do not involve negligence. =hat is Kiara4s negligence penalty for the >1130++ in deficiencies@ Answer The negligence penalty is >'5+ ,+.)+ B >)30++).
$age %ef. & 1'())

17 Copyright 2011 Pearson Education, Inc.

01) $a2lo3 a 2achelor3 owes >0+3+++ of additional taxes3 all due to fraud. =hat is the amount of the civil fraud penalty@ =hat criminal fraud penalty might 2e imposed under "ec. 7)+1@ Answer a. The civil fraud penalty is >5+3+++ ,+.7' B >0+3+++). 2. /nder "ec. 7)+1 the fine could 2e as high as >1++3+++. In addition3 !uis could receive a prison sentence of as long as five years.
$age %ef. & 1'()13 & 1'()'

0') Kelly3 a calendar year taxpayer3 files her )++0 individual return on ;arch .+3 )++*3 and pays the amount due at the same time. !ater3 she discovers some deductions that she should have claimed on the return. :y what date must she file a claim for refund@ Answer :y three years from the due date of the return3 that is3 2y April 1'3 )+1).
$age %ef. & 1'()03 & 1'()*

05) Kristina and Lictor filed a joint return for the current year. They are in the .18 marginal tax 2racFet. Lictor did not Fnow that Kristina failed to report a pri<e valued at >153+++ that she won. "he used the money to 2uy Lictor a motorcycle. Does Lictor meet the tests for relief under the innocent spouse provisions@ Answer $ro2a2ly not. Although ,1) Lictor and Kristina filed a joint return and ,)) the return contained an understatement of tax attri2uta2le to Kristina4s erroneous item3 and ,.) Lictor can esta2lish that he did not actually Fnow of the understatement he nevertheless had reason to Fnow. ?e had reason to Fnow 2ecause he 2enefited directly from Kristina4s pri<e. The receipt of this 2enefit should have alerted him to the re9uirement to report it as taxa2le income.
$age %ef. & 1'()*

07) Ane of your corporate clients comes to you asFing for advice regarding a proposed merger with MGN &ompany. Gou ,a) issue an opinion concerning the F;L of MGN3 ,2) prepare pro forma financials for the merged entity to 2e3 ,c) draft shareholder resolutions for your client approving the proposed merger3 ,d) file a shareholder proxy statement with the /.". "ecurities and #xchange &ommission3 and ,e) advise your client4s 2oard of directors concerning the advantages of a Type A versus a Type : reorgani<ation. =hich of these activities3 if any3 constitutes the unauthori<ed practice of law@ Answer Activities ,c) and ,d) constitute the unauthori<ed practice of law 2ecause they involve the drafting and filing of legal documents. Activities ,a) and ,2) fall within the traditional domain of accountants. Activity ,e) may properly 2e conducted 2y either accountants or lawyers.
$age %ef. & 1'(.7

00) Ane of your corporate clients has recently filed for 2anFruptcy. In the course of the proceedings3 you ,a) prepare a plan of reorgani<ation that alters the rights of preferred stocFholders3 ,2) notify the company4s creditors of an impending 2ulF transfer of the company4s assets3 ,c) review I%" secured claims against these assets3 ,d) restructure the company4s de2t 2y reducing its principal amount and extending its maturity3 and ,e) advise the 2anFruptcy court as to how this restructuring will impact the company4s -A!s. =hich of these activities3 if any3 constitutes the unauthori<ed practice of law@ Answer Activities ,a)3 ,2)3 and ,c) constitute the unauthori<ed practice of law 2ecause they potentially involve a determination or modification of the rights of the company4s stocFholders or creditors. Activity ,d) falls within the traditional domain of accountants. Activity ,e) may properly 2e conducted 2y either accountants or lawyers.
$age %ef. & 1'(.7

1 Copyright 2011 Pearson Education, Inc.

0*) =hich of the following communications 2etween an accountant and client are privileged@ a. During the preparation of her )++0 tax return3 Tammy informs her accountant that she contri2uted >)'3+++ to a 9ualified charita2le organi<ation. 2. After filing his tax return3 a client mentions to his accountant that he forgot to report a >73+++ pri<e that he one playing 2ingo. ?e asFs how he should correct the error. c. A client tells his accountant that he will no longer pay alimony to his ex(wife. Answer Anly communication ,2) is privileged 2ecause it is made for the purpose of o2taining professional tax advice. &ommunication ,a) is not privileged 2ecause it is made for tax preparation purposes only. &ommunication ,c) is not privileged 2ecause it does not involve a tax matter.
$age %ef. & 1'(.73 & 1'(.0

*+) =hich of the following communications 2etween an accountant and client are not privileged@ a. An accountant orally communicates to his client that he should set up a foreign su2sidiary to shift taxa2le income to a lower tax jurisdiction. 2. An accountant privately su2mits to the client a plan for shifting taxa2le income to a lower tax jurisdiction. c. During a meeting in which a client is asFing for advice relating to criminal fraud3 the client tells his accountant that he lied to the I%". Answer &ommunications ,2) and ,c) are not privileged3 the former 2ecause it involves a written communication relating to a tax shelter ,i. e. 3 any plan or arrangement3 a significant purpose of which is tax avoidance)3 the latter 2ecause it is discovera2le in a criminal proceeding. Although communication ,a) relates to a tax shelter3 it was not made in writing.
$age %ef. & 1'(.73 & 1'(.0

*1) #xplain how the Internal %evenue "ervice is organi<ed to 2e efficient and client(oriented. Answer The I%" is organi<ed functionally into four divisions ,1) =age and Investment3 ,)) "mall :usiness3 ,.) ;iddle ;arFetJ!arge &orporate3 and ,1) Tax #xempt. #ach division is headed 2y a divisional director. The =age and Investment Division is responsi2le for individual taxpayers who report only wage and investment income. ;ost of these taxpayers file Forms 1+1+3 1+1+A3 or 1+1+#N. The "mall :usiness Division is responsi2le for sole proprietors3 individuals with supplemental income3 and small corporations and partnerships. ;ost of these taxpayers file Forms 1+5' and 11)+" or "chedules &3 #3 and F. The ;iddle ;arFetJ!arge &orporate Division is responsi2le for corporations with assets of >' million or more. ;ost of these taxpayers file Form 11)+. The tax #xempt Division is responsi2le for tax(exempt organi<ations3 employee plans3 and state and local governments. ;ost of these entities file forms relating to tax exempt status. The shift to a functional mode of organi<ation reflects &ongress4 desire to render the I%" more efficient and client(oriented. Through this mode of organi<ation3 tax administrators can focus on their areas of technical expertise and3 taxpayers can deal with the same technical experts wherever they reside.
$age %ef. & 1'(.

1! Copyright 2011 Pearson Education, Inc.

*)) #xplain the four conditions that must 2e met in civil cases for the 2urden of proving any factual issue relevant to the determination of taxpayer lia2ility to rest with the I%". Answer The taxpayer must introduce 6credi2le evidence63 evidence of a 9uality sufficient to serve as the 2asis of a court decision. The taxpayer must comply with the record Feeping and su2stantiation re9uirements of the I%&3 including the proper documentation of meal and entertainment expenses3 charita2le contri2utions3 and foreign controlled 2usinesses. Also3 the taxpayer must cooperate with the reasona2le re9uests of the I%" for witnesses3 information3 documents3 meetings3 and interviews. Finally3 the taxpayer must 2e either a legal person with a net worth not exceeding >7 million or a natural person.
$age %ef. & 1'(1+

*.) #xplain one of the two exceptions to imposing interest from the original due date of the tax return until the date the tax deficiency is paid. Answer If the I%" fails to send an individual taxpayer a notice within 10 months after the original due date3 or the date on which a return is timely filed3 whichever is later3 the actual of interest ,and penalties) will 2e suspended. The suspension period 2egins on the day after the 10(month period and ends )1 days after the I%" sends the re9uisite notice. :eginning in )++13 the notice must 2e sent within one year after the aforementioned dates. If the I%" does not issue a notice and demand payment within .+ days after the taxpayer signs Form 07+3 =aiver of "tatutory -otice3 no interest can 2e charged for the period 2etween the end of the .+ day period and the date the I%" issues its notice and demand.
$age %ef. & 1'(11

*1) ?ow does a taxpayer determine if 6su2stantial authority6 exists for a tax treatment the taxpayer desires to adopt@ Answer A taxpayer should initially looF to primary sources for support for the position on a tax issue. "pecifically3 the taxpayer should consult &ode sections3 Treasury regulations3 revenue rulings3 revenue procedures3 determination letters3 and judicial opinions to assess the existence of su2stantial authority. The weight of authorities supporting a position should 2e 6su2stantial6 in relation to authorities going the other way. There can 2e su2stantial authority for more than one position.
$age %ef. & 1'()1

*') =hat is the difference 2etween the 2urden of proof for civil and criminal fraud@ Answer The 2urden of proof is &lear and convincing evidence ( civil fraud :eyond a reasona2le dou2t ( criminal fraud
$age %ef. & 1'()13 & 1'()'

*5) For innocent spouse relief to apply five conditions must 2e met3 explain them. Answer Five of the following conditions must 2e met A joint return is filed. The return contains an understatement of tax attri2uta2le to the erroneous item,s) of an individual filing it. The other individual esta2lishes that he or she neither Fnew nor had reason to Fnow of the understatement. :ased on all the facts and circumstances3 holding the other individual lia2le for the deficiency would 2e ine9uita2le. The other individual elects innocent spouse relief no later than two years after the I%" 2egins its collection efforts.
$age %ef. & 1'()*

20 Copyright 2011 Pearson Education, Inc.

*7) Dayne and Don jointly file a tax return this year. Dayne fraudulently reports on "chedule & two expenses >)3+++ and >)3'++. The I%" audits the return3 assesses a >13+'+ deficiency and 2egins collection efforts two years after the timely filing 2y Dayne and Don. =hat must Don do to 2e relieved of the >13+'+ tax lia2ility@ Answer Don must meet all five conditions to elect innocent spouse relief. ,1) The election must 2e made no later than two years after the I%" 2egins its collection efforts. ,)) Don must esta2lish that he neither Fnew nor had reason to Fnow of the understatement. ,.) ?olding Don lia2le for the deficiency would 2e ine9uita2le. ,1) A joint return was filed. ,') And3 the return contained an understatement of tax attri2uta2le to an erroneous item of an individual filing it.
$age %ef. & 1'(.+I #xample & 1'(.7

*0) ?ow does the I%" regulate the activities of compensated tax return preparers@ In particular3 list six acts that will cause a compensated tax return preparer to incur a penalty. Answer %egulation of tax return preparers occurs through &ode "ecs. 55*13 55*'3 55*53 57++3 57+13 75+)3 and Treasury Department &ircular ).+. These provisions are a representative listing of the practice re9uirements placed on preparers and3 among others3 include penalties for O Failure to furnish the taxpayers with a copy of the return O Failure to sign a return O Failure to furnish one4s identification num2er O Failure to Feep a copy of a return or maintain a list of taxpayers for whom returns were filed O Failure to disclose the names of employees who prepare returns O #ndorsement of a tax refund checF of a taxpayer O /nderstatement of tax 2ecause of taFing a position without a realistic possi2ility of it 2eing sustained. O =illful attempt to understate taxes and recFless or intentional disregard of rules or regulations. Treasury Department &ircular ).+ regulates the practice of attorneys3 &$As3 enrolled agents3 and enrolled actuaries 2efore the I%". Individuals who do not comply with the rules and regulations of &ircular ).+ can 2e 2arred from practicing 2efore the I%".
$age %ef. & 1'(.1(& 1'(..

**) &hristie and :illy jointly file this year. :illy intentionally omits >'3+++ in gam2ling winnings. &hristie fraudulently deducts >13+++ in 2usiness expenses. The I%" audits the return3 assesses a >)3'++ deficiency and 2egins collection efforts two years after the timely filing of the return. &hristie and :illy divorced one year 2efore the deficiency was assessed. &an &hristie receive any tax relief from the full >)3'++ deficiency@ Answer Ges3 under the proportional lia2ility election3 which is part of the innocent spouse provisions3 &hristie meets all four of the conditions at the time of her election divorced3 not residing with the other filer at anytime during the 1) month period preceding the election3 no actual Fnowledge of the gam2ling winnings3 and she will elect proportional lia2ility within two years after the I%" 2egins its collection efforts. &hristie will remain lia2le only for that portion of the deficiency attri2uta2le to her separate taxa2le items.
$age %ef. & 1'(.+I #xample & 1'(.0

21 Copyright 2011 Pearson Education, Inc.

1++) #xplain accountant(client privilege. =hat are the similarities and differences 2etween it and attorney(client privilege@ Answer According to judicial doctrine3 certain communications 2etween an attorney and a client are 6privileged36 i. e. 3 nondiscovera2le in the course of litigation. In l**03 &ongress extended this privilege to similar communications 2etween a federally authori<ed tax practitioner and a client. A federally authori<ed tax advisor includes a certified pu2lic accountant. The accountant(client privilege is similar to the attorney(client privilege in two respects. First3 it encompasses communications for the purpose of o2taining or giving professional advice. "econd3 it excludes communications for the sole purpose of preparing a tax return. The accountant(client privilege is dissimilar in three respects. First3 it is limited only to tax advice. "econd3 it may 2e asserted only in a noncriminal tax proceeding 2efore a federal court or the I%". Third3 it excludes written communications regarding a tax shelter 2etween an accountant and a corporation. A tax shelter is any plan or arrangement3 a significant purpose of which is tax avoidance or evasion. The creation of an accountant(client privilege reflects &ongress4 2elief that the selection of a tax advisor should not hinge on the 9uestion of privilege. It ensures that all tax advice is accorded the same protection regardless of the tax advisor4s professional status.
$age %ef. & 1'(.73 & 1'(.0

22 Copyright 2011 Pearson Education, Inc.

1+1) The I%" audited the tax returns of Dan DacFson3 a gifted painter. It contended that3 2etween )++. and )++'3 DacFson received >'++3+++ for his paintings3 2ut reported only >7'3+++. DacFson attri2uted the shortfall to his receipt of cash at art fairs and street fairs. ?e allegedly concealed the cash payments in separate 2anF accounts un2eFnownst to his &$A. =hat tax compliance issues regarding the alleged underreporting are pertinent to the &$A@ Answer Dan DacFson3 his agent3 and &$A ,tax return preparer) face a num2er of issues which include O Did an understatement of income occur as a result of misreporting the income received from the art fairs and street shows@ O Are the tax years in 9uestion still open years under the statute of limitations@ O =hat is the amount of the additional taxes owed ,if any) on the under reporting of income@ O =hat is the amount of the interest and penalties owed on the understatement of the tax lia2ility@ O =hat is the amount of the civil and criminal penalties that Dan DacFson faces@ O =hat tax(return(preparer3 civil3 and criminal penalties can 2e imposed 2y the I%" on the taxpayer4s agent andJor &$A for the underreporting of Dan DacFson4s tax lia2ility@ O =hat sanctions might the AI&$A andJor the appropriate "tate :oard of Accountancy impose on the tax return preparer@ The facts and circumstances of the situation will determine the penalties levied on Dan DacFson and his &$A. At a minimum3 a penalty will 2e imposed for failure(to(pay taxes. :ecause DacFson filed his tax return3 no failure(to(file penalty will 2e imposed. In addition3 interest may apply to the failure to maFe the appropriate estimated tax payments. A )+8 negligence penalty also may 2e imposed on DacFson if the I%" can show that the underpayment was due to negligence or disregard of the rules and regulations. Also3 a )+8 su2stantial understatement penalty may 2e imposed under "ec. 555),d). As an alternative3 the I%" may go for imposition of the civil and criminal fraud penalty. This would depend on the taxpayer4s intent. The statute of limitations may 2e extended from three to six years if more than )'8 of DacFson4s gross income was omitted from the tax return. ,=hether this penalty applies is not a2le to 2e ascertained from the pu2lic press information regarding the fairs. ) -o statute of limitations would apply if fraud could 2e proven. &riminal penalties under "ecs. 7)+13 7)+.3 or 7)+5 can lead to up to five years in prison. Larious provisions potentially apply against the tax return preparer. =e do not have enough information to Fnow which civil or criminal penalties3 if any3 may apply. If the &$A actively participated in the fraudulent activity3 he or she may lose the a2ility to practice as a &$A3 or may lose the a2ility to practice 2efore the I%". If the &$A had no Fnowledge of the fair activities3 etc. 3 it is unliFely that the &$A would lose his or her license to practice.
$age %ef. & 1'(1'(& 1'(173 & 1'()+(& 1'()*3 & 1'(.1(& 1'(..

23 Copyright 2011 Pearson Education, Inc.

1+)) Gou are preparing the tax return for Agre &orporation3 which has sales of >'+ million. Agre made a >) million expenditure for which the appropriate tax treatment3 deducti2le or capitali<a2le3 is a gray area. The corporation4s &hief Financial Afficer wants you to deduct the expenditure. =hat tax compliance issues should you consider in deciding whether to deduct the expenditure@ Answer O =ill you as the tax return preparer have sufficient support3 according to I%& "ec. 55*1 and the AI&$A4s "%T$3 to deduct the expenditure@ O =ill the client have su2stantial authority for a deduction@ O If not3 will the client have a reasona2le 2asis for deducting the expenditure@ O "hould you present a disclosure as part of the tax return a2out the expenditure if you deduct it@ :acFground comments the information presented is not complete enough for the students to conclude definitively whether the reasona2le 2asis and su2stantial authority standards are met. The pro2lem was designed3 however3 as an issue recognition pro2lem3 not a 9uestion for which there is a definitive answer. According to "ec. 55*1 and the AI&$A4s "tatements on "tandards in Tax "ervices3 you ,the preparer) should 2elieve that sufficient authority exists to meet the realistic possi2ility of 2eing sustained test. Treasury %egulations 9uantify this test as 2eing approximately a one( in(three liFelihood of 2eing sustained. If you do not 2elieve that sufficient authority exists for meeting this test3 you may adopt a pro(taxpayer position so long as you maFe a disclosure3 and the position is not frivolous. The su2stantial authority standard is less stringent than the more liFely than not ,P'+8) test. It means3 according to Treasury %egulations3 that the authorities supporting a position are su2stantial in relation to authorities going the other way. It is possi2le for su2stantial authority to 2e present for more than one position. Treasury %egulations explain that reasona2le 2asis refers to a position that is argua2le 2ut unliFely to 2e upheld in court. $rovided a disclosure is made and sufficient support exists to meet the reasona2le 2asis standard3 the client will not owe the su2stantial understatement penalty ,of "ec. 555)) in the event the I%" audits its return and it agrees to delete the >1 million deduction. =ithout such a disclosure3 the I%" might levy the )+8 su2stantial underpayment penalty. Furthermore3 the I%" might levy a >)'+ preparer penalty against you if you do not include a disclosure with the return.
$age %ef. & 1'()+(& 1'().3 & 1'(.1(& 1'(..

24 Copyright 2011 Pearson Education, Inc.

1+.) !atFa -ovatny gave you the following information to use in the preparation of his current year4s tax return. "alary >1)+3+++ Dividends )+3+++ Itemi<ed deductions .'3+++ In addition3 he received >1+3+++ from a relative for whom he had worFed previously. Gou have research whether the >1+3+++ should 2e classified as a gift or compensation and are confident that su2stantial authority exists for classifying it as a gift. =hat tax compliance issues should you consider in deciding whether to report or exclude the >1+3+++@ Answer O =ill !atFa 2e lia2le for a penalty if the >1+3+++ is excluded from his gross income@ O =hat statute of limitations will apply@ If you are correct in 2elieving that su2stantial authority exists for excluding the >1+3+++3 !atFa should not 2e su2jected to any penalties even if his return is audited and he agrees to include the >1+3+++ in his income. /nless a disclosure concerning the >1+3+++ is attached to !atFa4s return3 the statute of limitations will 2e six years ,from the date he files his return or from the due date for the return if later) instead of the regular three years. The reason is that he will have omitted from this gross income more than )'8 of the >11+3+++ of gross income reported on his return ,)'8 B >11+3+++ C >.'3+++). $erhaps3 !atFa would liFe to maFe a disclosure to have a shorter statute of limitations. This might 2e the case3 for example3 if some of the deductions he claimed fall into the gray area.
$age %ef. & 1'()1(& 1'().3 & 1'()'(& 1'()*

1+1) %ichard recently won a popular television reality show and its one million dollar pri<e. ?owever3 he omitted the pri<e money from his tax return for the year. =hat penalties can the I%" assess@ Answer O &riminal or civil fraud O -egligence or su2stantial understatement of tax ,if no fraud penalty levied) O Failure to pay O /nderpayment of estimated taxes ,depending on the amount of prior year taxes) The I%" will also charge interest on the underpayment.
$age %ef. & 1'()5

25 Copyright 2011 Pearson Education, Inc.