ACC 401 TAX 2/ 11

Understanding Tax Positions

Importance of Audits

• It is essential to ensure that a tax position will be sustainable during an audit process, as this examination is crucial for compliance and legitimacy.

• The aim should be to establish a likelihood of at least 50% that the position will prevail in court, which underscores the importance of reasonableness in tax positions.

• Avoid outlandish claims, such as qualifying a pet dog as a dependent, as these can easily be challenged and could lead to penalties.

Types of Authorities in Tax Law

Primary Authority

• Primary authorities provide direct legal authority from official sources of law and play a fundamental role in tax law decisions. The main components include:

  • Legislative Branch: Congress provides the raw legal framework through the Internal Revenue Code (IRC). This body of law guides tax treatment of various entities and transactions.

  • Executive Branch: This includes the IRS and the Treasury Department, which administers and interprets tax laws, offering regulations and guidance that clarify the application of the IRC.

  • Judicial Branch: Courts interpret tax law against specific facts, and their rulings create precedents that impact how the laws are applied in future cases.

Hierarchy of Primary Authorities

1. Internal Revenue Code (IRC): Represents the highest authority in tax law, outlining the legal framework to be followed.

2. Treasury Regulations: Issued by the Treasury, these regulations provide clarity and detailed examples concerning specific sections of the IRC.

3. Revenue Rulings and Revenue Procedures: These documents give further guidance on tax matters and situations, although they are less authoritative than the code and regulations.

4. Letter Rulings: Tailored interpretations provided for individual cases based on specific facts submitted to the IRS, often serving as guidance for similar legal circumstances.

5. Court Cases: Legal precedents that establish applications of tax law, thus providing judicial interpretations that must be considered in similar future cases.

Understanding Secondary Authorities

• Secondary Authorities: These sources cannot be relied upon as primary sources but serve to explain or interpret laws. Examples include:

  • Tax handbooks, practice guides, and academic texts which provide insights but do not have the weight of law.

• The IRS website, while considered an authoritative source, is lower on the hierarchy than primary authorities but can be a valuable resource for understanding IRS policies and frequently asked questions.

Practical Examples of Tax Positions

Family Analogy for Authorities

• Primary Sources: Are like direct authority from parents—clear and unquestionable sources of guidance.

• Secondary Sources: Compare to advice from extended family or friends that guide but do not dictate rules.

Sleepover Analogy:

• Straightforward Rule: An example rule might be no sleepovers before the age of eight, representing a clear directive from a primary source.

• Secondary Guidance: Approaching parents for exceptions demonstrates a more informal understanding of rules that could lead to flexibility.

• Private Ruling Concepts: This can be likened to getting parental assurance based on presented evidence or strong reasoning, akin to seeking specific rulings from the IRS.

Structuring Tax Research

• Structured Approach: Start with conclusions to understand the final objectives, then address the specific issues, rules, applications, and how they interact logically.

• Example Scenario: Utilizing the sleepover permission analogy helps create engagement and contextual relevance around complex tax law concepts, making them easier to understand.

Understanding Deductions

Classification of Deductions

• Deductions can be classified into two main categories:

  • For AGI (Adjusted Gross Income): These deductions reduce AGI without needing to itemize. Examples include educator deductions, student loan interest, and self-employment taxes.

  • From AGI: These deductions are available only if itemization occurs, like charitable contributions and mortgage interest payments.

Impact of Standard Deductions

• Understanding the limits of various deductions also depends on AGI thresholds, with specific limits applied based on filing status (e.g., married filing jointly).

Internal Revenue Codes (IRC) and Deductions

Important Sections:

• IRC Section 162: Establishes guidelines for deducting ordinary and necessary business expenses incurred for conducting trade or business.

• IRC Section 212: Allows deductions for expenses pertaining to the production of income, particularly in investment-related activities.

Tax Case Examples

• Tax Deductible Examples: Legitimate, business-related expenses, like a movie producer attending shows for market research, can be deducted.

• Differentiating Costs: Distinguishing between necessary and excessive business expenses is vital, as extravagant costs rarely are deductible unless placed under scrutiny to establish their business relevance.

• Illegal Business Expenses: Discussing the legality of expenses also impacts deductibility and must be understood to avoid tax evasion traps.

Common Questions About Deductions

• Personal Expenses: Generally, personal expenses are not deductible unless they conform to clearly outlined rules or pertain to specific exceptions for employees.

• Fringe Benefits: Clarification is needed on what constitutes taxable versus non-taxable benefits under the various IRC sections, such as how airline tickets given as gifts are treated.

Complexities in Tax Deductions

QBI Deduction:

• Qualified Business Income Deduction: Primarily structured for sole proprietorships, partnerships, and S corporations, this deduction is contingent on specific income thresholds and limitations under W-2 wages.

Conclusion and Next Steps

• A broad understanding of all aspects of tax authority enhances the efficacy of research projects and the applicability of tax knowledge in real-world scenarios.

• The complexity of taxes necessitates a keen reliance on primary sources to ensure success and accuracy in positions taken and arguments formed in tax-related matters.

• It is crucial to submit upcoming projects in the prescribed format, emphasizing the reliance on primary authorities.