17
TAX CHAPTER PRACTICE AND ETHICS
MULTIPLE CHOICE
1. The Chief Counsel of the IRS is appointed by the:
a. Secretary of the Treasury Department.
b. U. S. Senate.
c. U. S. House of Representatives.
d. U. S. President.
e. American Bar Association President.
ANS: D
OBJ: 1
MSC: 5 min
PTS: 1
DIF: 1
REF: p. 17-4
NAT: AICPA FN-Measurement | AACSB Analytic
2. Which statement appearing below does not correctly describe the IRS letter ruling process?
a. In certain situations, the IRS will not issue a ruling.
b. Some letter rulings are of such importance and general interest that they are later
published (in anonymous form) as Revenue Rulings.
c. Letter rulings benefit both taxpayers and the IRS.
d. Letter rulings are private and are not open to public inspection.
ANS: D
Letter rulings are open to public inspection after identifying details and certain confidential information
have been deleted. Such rulings are reprinted and published by the commercial tax services, available
in full text by subscription.
PTS: 1
OBJ: 2
MSC: 5 min
DIF: 1
REF: p. 17-4 | p. 17-5
NAT: AICPA FN-Research | AACSB Analytic
3. With respect to the audit process, which of the following statements is incorrect?
a. Only the Appeals Division of the IRS has the authority to settle tax disputes based on
the hazards of litigation.
b. The IRS does not publish the factors it uses for audit selection purposes annually in the
Commissioners Report.
c. For a Form 1040 that is filed on April 11, 2011, if the taxpayer has not received an audit
notification from the IRS by the end of 2011, the return may still be audited.
d. If the taxpayer makes a math error on the Form 1040, an office audit automatically is
triggered.
ANS: D
17-1
17-2
2011 Annual Edition/Test Bank
The IRS does not disclose its audit selection techniques, p. 17-7. As to option a., Example 7. As to
option c., p. 17-23. As to option d., p. 17-9.
PTS: 1
OBJ: 3 | 4 | 7
MSC: 5 min
DIF: 2
REF: p. 17-7 to 17-10 | p. 17-22 to 17-24 | Example 7
NAT: AICPA FN-Risk Analysis | AACSB Analytic
4. With respect to the audit process, which statement is correct?
a. Office audits are conducted at the office of the taxpayer.
b. The most common type of Federal income tax audit is the correspondence audit.
c. An office audit typically is used for a business taxpayer.
d. A correspondence audit usually is concluded after a meeting with the taxpayer at the
IRS auditors office.
ANS: B
OBJ: 3
MSC: 5 min
PTS: 1
DIF: 1
REF: p. 17-9 | p. 17-10
NAT: AICPA FN-Risk Analysis | AACSB Analytic
8. The penalty for substantial understatement of tax liability does not apply if:
a. The taxpayer has substantial authority for the treatment taken on the tax return.
b. The relevant facts affecting the treatment are adequately disclosed in the return or on
Form 8275.
c. The IRS failed to meet its burden of proof in showing the taxpayers error.
d. All of the above statements are correct.
e. None of the above statements are correct.
ANS: D
OBJ: 6
MSC: 5 min
PTS: 1
DIF: 1
REF: p. 17-18
NAT: AICPA FN-Measurement | AACSB Analytic
9. Max (a calendar year taxpayer) donates a painting to a local art museum (a qualified charity). The
painting cost Max $2,000 ten years ago and, according to one of Maxs friends (an amateur artist), is
worth $50,000. On his income tax return, Max deducts $50,000 as a charitable contribution. Upon later
audit by the IRS, it is determined that the true value of the painting was $30,000. Assuming that Max
is subject to a 30% marginal income tax rate, his penalty for overvaluation is:
a. $0.
b. $1,200.
c. $2,400.
d. $5,000 (maximum penalty).
e. $6,000.
ANS: B
Maxs penalty for overvaluation is $1,200 [20% (penalty tax due to overvaluation) $6,000 (the
additional tax for using $50,000, and not $30,000)].
PTS: 1
DIF: 1
REF: p. 17-18
NAT: AICPA FN-Measurement | AACSB Analytic
OBJ: 6
MSC: 5 min
Tax Practice and Ethics
17-3
14. George, a calendar year taxpayer subject to a 45% marginal gift tax rate, made a gift of a sculpture to
Redd, valuing the property at $100,000. The IRS later valued the gift at $140,000. The applicable
undervaluation penalty is:
a. $7,200.
b. $3,600.
c. $1,000 (minimum penalty).
d. $0.
ANS: D
Additional tax ($18,000) exceeds $5,000, but the reported valuation is not 65% or less than the correct
valuation.
PTS: 1
DIF: 1
REF: p. 17-19
NAT: AICPA FN-Measurement | AACSB Analytic
OBJ: 6
MSC: 5 min
15. Leroy, who is subject to a 45% marginal gift tax rate, made a gift of a sculpture to Marvin, valuing the
property at $150,000. The IRS later valued the gift at $400,000. The applicable undervaluation penalty
is:
a. $0.
b. $22,500.
c. $25,000 (maximum penalty).
d. $45,000.
ANS: D
$112,500 additional tax 40% penalty rate for gross undervaluation.
PTS: 1
DIF: 1
REF: p. 17-19
NAT: AICPA FN-Measurement | AACSB Analytic
OBJ: 6
MSC: 5 min
17. The special tax penalty imposed on appraisers:
a. Applies if the appraiser knew that the appraisal would be used in preparing a Federal
income tax return.
b. Does not apply if the appraiser did not know that the appraisal would be used in
preparing a Federal income tax return.
c. Equals 10% of the appraised value of the property.
d. Can be as much as 200% of the appraisal fee that was charged.
ANS: A
As to choice b., the standard is whether the appraiser knew or should have known of the use on a tax
return.
PTS: 1
DIF: 1
REF: p. 17-19
NAT: AICPA FN-Measurement | AACSB Analytic
OBJ: 6
MSC: 5 min
18. Concerning the penalty for civil fraud applicable to taxpayers:
a. Fraud is defined in Code 6663(b) and (f).
b. The burden of proof to establish the penalty is on the government.
c. The penalty is 100% of the underpayment.
d. The penalty is applied before any other accuracy-related penalty.
ANS: D
OBJ: 6
PTS: 1
DIF: 1
REF: p. 17-20
NAT: AICPA FN-Measurement | AACSB Analytic
17-4
2011 Annual Edition/Test Bank
MSC: 5 min
19. Concerning a taxpayers requirement to make quarterly estimated tax payments:
a. An estate is not required to make estimated payments.
b. A trust must make estimated payments if its Federal income tax liability for the year
will exceed $500.
c. A C corporation must make estimated payments if its Federal income tax liability for
the year will exceed $250.
d. An individual must make estimated payments if his or her balance due for the Federal
income tax for the year will exceed $1,000.
ANS: D
OBJ: 6
MSC: 5 min
PTS: 1
DIF: 1
REF: p. 17-20
NAT: AICPA FN-Measurement | AACSB Analytic
22. The usual three-year statute of limitations on additional tax assessments applies in the following
situation(s).
a. No return at all is filed.
b. An investment in a marketable security is worthless.
c. Taxpayer discovers an inadvertent overstatement of deductions equal to 5% of gross
income.
d. Taxpayer inadvertently omits an amount of gross income in excess of 25% of the gross
income stated on the return.
ANS: C
Option a. has no statute of limitations. Option b. has a seven-year statute of limitations. Option d. has a
six-year statute of limitations.
PTS: 1
OBJ: 7
MSC: 5 min
DIF: 1
REF: p. 17-22 | p. 17-23
NAT: AICPA FN-Risk Analysis | AACSB Analytic
28. Which of the following is subject to tax return preparer penalties?
a. Lizzie, the firms administrative assistant, makes copies of returns and assembles the
mailings that the client must make to the taxing agencies.
b. Meredith is the director of Federal taxes for a C corporation.
c. Sammy is a volunteer who prepares returns at the retirement home under the IRS Tax
Counseling for the Elderly program.
d. Abbie prepares her mothers tax returns for $50 a year. A CPA, Abbie would charge a
client $750 for completing a similar return.
ANS: D
OBJ: 8
MSC: 5 min
PTS: 1
DIF: 1
REF: p. 17-24
NAT: AICPA FN-Risk Analysis | AACSB Analytic
29. Roger prepared for compensation a Federal income tax return for Joan. Joans return included an
aggressive interpretation of the rules concerning overnight business travel. Roger is not liable for a
preparer penalty for taking an unreasonable tax return position if:
a. There was substantial authority for Joans interpretation of the travel deduction rules.
b. There was a reasonable basis for Joans interpretation of the travel deduction rules.
c. The tax reduction attributable to the disputed deduction did not exceed $5,000.
d. The IRS found that the travel deduction was frivolous, but Joan disclosed the position in
Tax Practice and Ethics
17-5
an attachment to the return.
ANS: A
OBJ: 8
MSC: 5 min
PTS: 1
DIF: 1
REF: p. 17-25 | p. 17-26
NAT: AICPA FN-Risk Analysis | AACSB Analytic
30. Roger prepared for compensation a Federal income tax return for Joan. Joans return included an
aggressive interpretation of the rules concerning overnight business travel. Roger is not liable for a
preparer penalty for taking an unreasonable tax return position if:
a. Joan is assessed her own penalty for an understatement of tax due to disregard of IRS
rules.
b. There was a reasonable basis for Joans interpretation of the travel deduction rules, and
Joan disclosed the position in an attachment to the return.
c. The tax reduction attributable to the disputed deduction did not exceed $5,000.
d. The IRS found that the travel deduction was frivolous, but Joan disclosed the position in
an attachment to the return.
ANS: B
OBJ: 8
MSC: 5 min
PTS: 1
DIF: 1
REF: p. 17-25 | p. 17-26
NAT: AICPA FN-Risk Analysis | AACSB Analytic
31. Freddie has been assessed a preparer penalty for willful and reckless conduct. When he completed
Peggys Federal income tax return (who is in the 35% tax bracket), Freddie purposely omitted
$100,000 of cash receipts that should have been reported as gross income. Freddie charged Peggy
$6,000 to prepare the return. What is Freddies preparer penalty?
a. $0, because Peggy incurred her own understatement penalty for the return.
b. $3,000.
c. $5,000.
d. $17,500.
ANS: C
The penalty for willful and reckless conduct is the greater of $5,000 or one-half of the preparers fee.
PTS: 1
DIF: 1
REF: p. 17-28
NAT: AICPA FN-Measurement | AACSB Analytic
OBJ: 8
MSC: 5 min
ESSAY
1. Why should the tax practitioner study the workings of the IRS?
ANS:
The tax practitioner needs to study the workings of the IRS so as to:
Be able to apply and use to the taxpayers advantage the administration process and the
opportunities for appeal provided by the law.
Understand the negative sanctions, such as penalties and interest, that may be brought to
bear when the taxpayer is unsuccessful taking in a tax return position.
Apply the ethical and professional constraints that relate to the advice that a tax practitioner
gives to a client.
17-6
2011 Annual Edition/Test Bank
PTS: 1
DIF: 1
REF: p. 17-2
NAT: AICPA FN-Risk Analysis | AACSB Analytic
OBJ: 1 | 3 | 8
MSC: 5 min
3. Who are the top two personnel within the IRS? What are their chief responsibilities?
ANS:
Both the Commissioner and the Chief Counsel are presidential appointees.
The Commissioner is in charge of the day-to-day operations of the agency. The agency is organized
into four operating divisions, mainly by the types of tax return that they review. Additional functions
include shared services, litigation, investigations, and taxpayer relations.
The Chief Counsel functions as the IRS attorney. As the agencys chief legal officer, the Chief
Counsel establishes the IRS positions as to tax matters, drafts guidance for taxpayers and IRS
personnel, issues technical rulings on tax matters, and represents the IRS in all tax litigation.
PTS: 1
OBJ: 1
MSC: 5 min
DIF: 1
REF: p. 17-4 | Figure 17.1
NAT: AICPA FN-Measurement | AACSB Analytic
5. Describe the following written determinations that are issued by the IRS.
a.
Determination letter.
b.
Technical advice memorandum.
c.
Technical expedited advice memorandum.
ANS:
a. A determination letter relates to a completed transaction, and its application to the tax law.
The National Office discloses its position as to a taxpayers inquiry into, say, whether a
retirement plan qualifies for tax deferred treatment.
b.
A technical advice memorandum (TAM) relates to an item that is disputed during an IRS
audit. The revenue agent or other IRS personnel requests a ruling as to, say, whether a
deduction or credit should be allowed.
c.
A technical expedited advice memorandum produces a ruling from the IRS in a shorter
time than would be the case for a TAM. The parties stipulate to an agreed set of facts and
hold a presubmission conference, so as to clarify and limit the issues that are in dispute.
PTS: 1
OBJ: 2
MSC: 10 min
DIF: 1
REF: p. 17-5 | p. 17-6
NAT: AICPA FN-Risk Analysis | AACSB Analytic
6. Identify a profile for a taxpayer who is more likely than the national average to be audited by the IRS.
ANS:
These circumstances likely increase ones chances to be audited this year.
Tax Practice and Ethics
Type of tax return: high-income, self-employed, cash-oriented
Information returns do not match contents of the tax return
Itemized deductions claimed in excess of national averages
A claim for refund is involved
Subject of an IRS industry target program (e.g., returns with passive losses, returns of
physicians)
Notification provided by an informant or whistleblower
17-7
Identified by IRS audit staff from other information sources (e.g., newspapers, web pages,
other Federal government agencies)
PTS: 1
OBJ: 3
MSC: 10 min
DIF: 1
REF: p. 17-7 | p. 17-8
NAT: AICPA FN-Risk Analysis | AACSB Analytic
8. If a taxpayer is audited by the IRS and is unwilling to accept the findings of the agent, how does the
taxpayers audit strategy change when the dispute is taken to the IRS Appeals Division? Hint: What
are the hazards of litigation?
ANS:
The taxpayer may attempt to negotiate an administrative settlement with the Appeals Division of the
IRS. A settlement, in part or in whole, may be possible at this level of administrative appeal because
the Appeals Officer may settle issues based on the hazards of litigation, whereas an agent must adhere
strictly to IRS policy as reflected in published court cases and Treasury Rulings, Regulations and other
releases. It also may be possible to reach an overall favorable settlement through a trading of
disputed issues.
PTS: 1
OBJ: 3 | 4
MSC: 10 min
DIF: 2
REF: p. 17-11 | p. 17-12 | Example 7
NAT: AICPA FN-Risk Analysis | AACSB Analytic
11. Over the last two decades, the Treasury has enforced numerous means by which to identify those
taxpayers who use tax shelter devices, and to eliminate any resulting losses and deductions. Special
reporting requirements apply to transactions that the IRS has labeled tax shelters. Describe those
requirements.
ANS:
17-8
2011 Annual Edition/Test Bank
Tax shelter arrangements, often involving leveraged financing and accelerated interest and cost
recovery deductions, are believed by the government to be solely supported by tax-reduction
motivations, and not related to business or profitability goals.
A tax shelter organizer must register the shelter with the IRS before any sales are made to investors. A
penalty of up to $10,000 is assessed if the required information is not filed with the IRS. This includes
a description of the shelter and the tax benefits that are being used to attract investors. The shelter
organizer must maintain a list of identifying information for all of its investors, which must be
available for IRS review. Failure to fully and truthfully maintain this list can result in a penalty of up to
$100,000 per investment.
PTS: 1
DIF: 1
REF: p. 17-21
NAT: AICPA FN-Reporting | AACSB Analytic
OBJ: 6
MSC: 10 min
12. What taxpayer penalties can arise when a tax return includes an item that is assigned a fair market
value?
ANS:
Several penalties might arise with respect to valuation questions on a tax return.
An overvaluation penalty might be imposed when the taxpayer, say, overstates the
amount of a deduction. The basic penalty is 20% of the tax reduction that resulted from
the overvaluation. Defenses to the penalty include reasonable cause and good faith
efforts.
An undervaluation penalty might arise when the taxpayer, say, understates the value of
an asset on an estate or gift tax return. The basic penalty is 20% of the tax reduction
that resulted from the undervaluation. Defenses to the penalty include reasonable cause
and good faith efforts.
A penalty can be assessed on an appraiser where it was more likely than not that the
appraised value used on a tax return was improper. The basic penalty is 10% of the
understated tax attributable to the appraisal. This penalty is assessed in addition to the
taxpayer valuation penalties discussed above.
PTS: 2
OBJ: 6
MSC: 10 min
DIF: 1
REF: p. 17-18 to 17-20
NAT: AICPA FN-Risk Analysis | AACSB Analytic
13. Summarize the penalties for a failure to pay an adequate amount of estimated taxes.
ANS:
C corporations must make estimates when their tax liability is a least $500. For all other taxpayers, this
amount is $1,000. The payments are due on the fifteenth day of April, June, September, and the
succeeding January, for calendar year taxpayers. A calendar year C corporation makes its fourth
quarter payment by December 15 of the tax year.
Tax Practice and Ethics
17-9
A taxpayer other than a C corporation must remit at least 90% of the current year tax or
100% of the prior year tax. The 100% requirement becomes 110% if an individuals
prior-year AGI exceeds $150,000. For the prior-year method, a return must have been
submitted for a full twelve-month tax year.
A C corporation must remit at least 100% of the current year tax or 100% of the prior
year tax. For the prior-year method, a nonzero tax amount must have been shown on a
tax return submitted for a full twelve-month tax year. Large corporations can use the
prior-year method only on the first quarter payment.
The penalties are assessed on a quarterly basis. Annualized income computations may be
used by the taxpayer to compute the quarterly tax amount due.
PTS: 2
OBJ: 6
MSC: 10 min
DIF: 2
REF: p. 17-20 | p. 17-21
NAT: AICPA FN-Risk Analysis | AACSB Analytic
16. Carole, a CPA, feels that she cannot act as an aggressive advocate for tax clients in todays
environment. What aspects of the ethical conduct of a tax practice might have influenced Caroles
attitude?
ANS:
Carole might be reacting to the general increase in the regulation of the tax profession that has
occurred in the last decade. Due to more aggressive pressure from Congress to close the tax gap and
public demands for transparency after the Enron and other reporting disasters, there have developed
greater pro-government influences on the ethical conduct of a tax practitioner. These include some of
the following items.
Increased disclosure standards to avoid preparer penalties (e.g., taking unreasonable tax
return positions).
Increased dollar amounts of certain preparer penalties.
Penalties assessed for the actions of appraisers, attorneys, and other parties conceivably
involved in a tax understatement.
Penalty assessed for any disallowed refund claim.
Limitations on the CPA/taxpayer confidentiality privilege.
PTS: 1
OBJ: 8
MSC: 10 min
DIF: 2
REF: p. 17-19 | p. 17-25 to 17-28
NAT: AICPA FN-Risk Analysis | AACSB Analytic
17. Does the tax preparer enjoy an attorney-client privilege of confidentiality with his or her clients?
ANS:
17-10
2011 Annual Edition/Test Bank
A limited confidentiality privilege is granted to non-attorneys with respect to tax-related work. The
privilege applies only with respect to contacts with the IRS, and not with other Federal agencies such
as the SEC. The privilege does not apply with respect to either criminal charges or transactions
involving tax shelters. The tax preparers privilege corresponds with that which would be available
between an attorney and his/her client in the relevant U.S. state.
The privilege relates to the preparation of a Federal tax return while business and other tax advice are
not protected.
The privilege does not protect the tax professionals tax accrual workpapers prepared for a client,
since these relate to the preparation of financial statements. See Chapter 14.
PTS: 1
DIF: 1
REF: p. 17-28
NAT: AICPA FN-Risk Analysis | AACSB Analytic
OBJ: 8
MSC: 5 min
18. CPA Jennifer has heard about the AICPAs Statements on Standards for Tax Services. Although
Jennifer is a licensed CPA in her state, she is not a member of the AICPA. How do the Statements
affect Jennifers tax practice?
ANS:
The Statements are enforceable standards of practice for AICPA members who are involved in a
Federal or state/local tax practice. As Jennifer is not a member of the AICPA, the Statements are not
binding on her. Nevertheless, she is subject to her states ethical rules applicable to CPAs and to those
contained in Circular 230, as well as the penalty provisions included in the Code.
PTS: 1
DIF: 1
REF: p. 17-29
NAT: AICPA FN-Risk Analysis | AACSB Analytic
OBJ: 8
MSC: 5 min