INCOME TAX PLANNING in .NET

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INCOME TAX PLANNING
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178 - Income Tax Planning
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TOPIC 57: INCOME TAX LAW FUNDAMENTALS
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1 Sources of authority A Primary (1) Statutory laws (a) Internal Revenue Code of 1986 The primary source of tax law (b) Taxpayer Relief Act of 1997 Included more than 300 new provisions and 800 changes to the Internal Revenue Code of 1986 (c) Tax legislative process begins with the House Ways and Means Committee and later goes to the House of Representatives If the House approves the bill, it is submitted to the Senate Finance Committee and then to the entire Senate If approved with no changes, it goes to the president for approval or veto If there are changes, the Joint Conference Committee will address them and submit the bill back to the House and Senate (2) Administrative pronouncements (a) Treasury regulations The of cial interpretation of a statutory tax rule written and published by the US Treasury; the highest source of authority next to the Internal Revenue Code Treasury regulations have the full force and effect of the law (b) Revenue rulings Represent the of cial position of the Internal Revenue Service (IRS), but carry less authority than the Code and regulations They provide interpretations of the tax law and give guidance to taxpayers (c) Revenue procedures These also represent the of cial position of the IRS They are generally related to compliance matters such as tax tables, in ation-indexed amounts, asset class lives, and so forth (d) Letter rulings More speci c interpretations by the national of ce of the IRS related to the tax consequences of a contemplated transaction at the request of the taxpayer A letter ruling is applicable only to the taxpayer who requested it and cannot be used by another taxpayer in a dispute (3) Judicial decision (a) Taxpayers can escalate any tax dispute to a regional appeals of ce of the IRS (b) If a case is unresolved, the taxpayer can take it to federal court for judicial review, consisting of three trial courts i US Tax Court Refuse to pay de ciency No jury trial ii US District Court Pay the de ciency and sue for a refund Provides a jury trial iii US Court of Federal Claims Pay the de ciency and sue for a refund No jury trial (c) If the case is still unresolved, the taxpayer can appeal to the US Circuit Court of Appeals (appellate court); 13 courts, based on jurisdiction (d) The nal appeal is to the US Supreme Court, which may agree to hear the case or refuse to hear it Any ruling is equivalent to law B Secondary sources of tax information consist mainly of books, periodicals, articles, newsletters, and editorial judgments in tax services 2 Research sources Research of a tax question involves the following steps: A Gather all the facts B Diagnose the problem
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Topic 58: Tax Compliance - 179 C D E F Locate the authority Evaluate the authority Derive the solution Communicate the answer
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TOPIC 58: TAX COMPLIANCE
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1 Filing requirements A Every individual US citizen and resident alien must le an income tax return when gross income exceeds the standard deduction amount plus the applicable personal exemption for the individual s ling status Example: A married couple ling jointly for 2002 with $6,000 personal exemption must le a tax return if their income exceeded $13,850 ($7,850 standard deduction + $6,000 personal exemption) The return must be led whether or not any tax is due B The previous rules do not apply to an individual who is claimed as a dependent by another The dependent must le a return if (1) His or her unearned income is more than $750 (for 2003) plus any additional standard deduction claimed because of age or blindness (2) His or her total gross income is more than the standard deduction C No return is necessary for a child if the parents elect to include the child s income in the parents return under the kiddie tax rules (see Topic 59, Section 12) D The following individuals have to le a tax return even if their gross income is below the required amount: (1) An individual who has $400 or more net earnings from self-employment (2) Individuals who have received tips from which Social Security tax was not withheld (3) Individuals owing alternative minimum tax (4) Employees of certain religious and other church-controlled organizations (5) Nonresident alien individuals (6) Individuals who have changed their country of residence or citizenship during the year (7) Individuals who must pay tax from an IRA or quali ed retirement plan (8) Individuals who must pay tax from recapture of investment credit, low-income housing credit, or federal mortgage subsidy E Most individuals are required to le Form 1040 by April 15 of the following year Individuals who have adopted a scal year must le by the 15th day of the fourth month following the close of the taxable year Corporations must le a tax return before the 15th day of the third month after the end of their tax year F The law permits individuals to le an automatic four-month extension (three-month extension for partnerships, trusts, and estates and six-month extension for corporations) The extension is only for ling the return, not for paying tax From the government s perspective, taxpayers who are late in paying taxes are receiving a loan from the government The IRS bills these taxpayers for interest owed from the required payment date to the date the delinquent tax is actually paid G Corporations may deduct the interest paid on a tax de ciency as a business expense For individual lers, the interest paid is nondeductible personal interest 2 Authority to represent the clients before the IRS (Circular 230) Certi ed public accountants (CPAs), attorneys, and enrolled agents have authority to represent a client before the IRS Enrolled agents receive certi cation to practice before the IRS by passing a tax exam written and administered by the IRS
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180 - Income Tax Planning 3 Audits A There are several ways in which the IRS chooses tax returns for audit (1) Discriminate Functions System (DIF) Score Method of screening all returns based on a precomputed set of weighted norms used in selecting returns to audit Based on the weighted score, the program ranks the returns from most auditworthy to least auditworthy The higher the score, the greater the chance of audit The DIF selection process is a closely guarded secret of the IRS The following are 10 items that practitioners consider topics of audit: (a) 1040 business returns with total gross receipts (TGR) of $100,000 or more, or with substantial business losses (b) 1040 nonbusiness returns with total positive income (TPI) of $50,000 or more (c) Returns with tax shelter activity (d) Returns prepared by an individual or rm on the Problem Preparer s List of the IRS (e) Travel and entertainment expenses (f) Business automobile expenses (g) Casualty losses (h) Barter income (i) Deduction for of ce-in-the-home expenses (j) Hobby losses (2) Taxpayer Compliance Measurement Program (TCMP) Designed to compute the norms used by DIF, thereby determining where taxpayers are most likely to fail in complying with the law (55,000 returns every two years) (3) Targeted programs Target professions with income derived from tips and the like, or speci c situations (4) Document matching programs Match speci c documents such as W-2s, 1099s, and so forth, to determine discrepancies (5) Random sample B Correspondence examinations The most common and simplest form of audit is usually conducted by telephone or mail C Of ce examination takes place at the IRS district of ce; eld examination takes place at the taxpayer s business Field audits are broader in scope than of ce examinations 4 Penalties A Late- ling and late-payment penalty A combined penalty that equals 5 percent of the balance of tax due for each month that the return is late, up to 5 months (until penalty equals 25 percent of balance due) After 5 months, the penalty is 05 percent for each month late, for an additional 45 months B Statute of limitations (1) The government s cashing a taxpayer s check or mailing a refund does not mean that the IRS has accepted the accuracy of the return as led (2) The statute of limitations gives the IRS three years from the later of the statutory due date (usually April 15) or the date on which the return was actually led to examine a return for mistakes (3) The statute of limitations is extended for six years if the taxpayer omits an amount of gross income exceeding 25 percent of the gross income reported C Negligence
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Topic 59: Income Tax Fundamentals and Calculations - 181 (1) The penalty equals 20 percent of any underpayment of tax attributable to the taxpayer s failure to make a reasonable attempt to comply with the law or intentional disregard of the law (2) The IRS has the burden of production to show that the taxpayer was negligent rather than he or she made an honest mistake This means the IRS must show a preponderance of evidence that negligence occurred D Civil fraud (1) The penalty is 15 percent for each month a return is late, up to a maximum of 75 percent Fraud is de ned as an intentional act of trying to cheat the government (2) The burden of proof for establishing fraud falls on the IRS The IRS must show clear and convincing evidence that fraud actually occurred E Criminal fraud (1) Also known as tax evasion, this it is a felony offense, punishable by severe monetary nes (up to $100,000 for an individual and $500,000 for a corporation) and by imprisonment in a federal jail (2) There must be guilt beyond a reasonable doubt for a person to be convicted F Tax return preparer penalties (1) An income tax preparer is any person who prepares tax returns (or employs other people to prepare returns) for compensation (2) If the preparer understates the amount of tax, and he or she knows (or should know) that the position has no merit, the IRS can impose a $250 penalty If there is a willful attempt to understate taxes, the ne increases to $1,000
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