Chapter 26 Flashcards by Heather Smith

Tax Administration (slide 1 of 3)

• The IRS is responsible for administration and enforcement of the tax laws
– Provides info to taxpayers through publications and forms with instructions so taxpayers can comply with the tax law
– Identifies delinquent tax payments
– Carries out assessment and collection procedures

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Tax Administration (slide 2 of 3)

• In meeting its responsibilities, the IRS conducts audits of selected tax returns
– About .6% of all individual tax returns are audited each year
– Certain tax returns, such as those for high income individuals or cash-oriented businesses, have a much higher audit rate

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Tax Administration (slide 3 of 3)

• To enhance its enforcement efforts, the IRS has focused much effort on:
– Developing requirements for information reporting and document matching
– Increasing pressure on tax advisers
• The IRS has recently undertaken a major reorganization and adopted new operational strategies aimed at improving its efficiency while enhancing its interaction with taxpayers

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Letter Rulings (slide 1 of 3)

When a tax issue is controversial or involves significant tax dollars, a taxpayer may request a letter ruling from the IRS
The ruling provides a written statement of the position of the IRS concerning the tax consequences of a course of action contemplated by the taxpayer

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Letter Rulings (slide 2 of 3)

• The ruling can only be relied upon by the party requesting the ruling
– Other taxpayers may use the ruling as an indication of the IRS’ position on the matter
• Letter rulings are generally followed by the IRS for the taxpayer who requested the ruling as long as all material facts of the transaction were accurately disclosed in the ruling request

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Letter Rulings (slide 3 of 3)

Letter rulings may be declared obsolete by the IRS for other taxpayers
A fee is charged by the IRS for processing a ruling request

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Determination Letters

• Provide guidance regarding a completed transaction when the issue involved is covered by judicial or statutory authority, regulations, or rulings– Issued for various estate, gift, income, excise, and employment tax matters

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Technical Advice Memorandum

• Issued by the National Office to IRS personnel in response to a request by an agent, Appellate Conferee, or IRS executive
– May be requested by taxpayer when an issue in dispute is not treated by the law or precedent and/or published rulings or regulations
– Also appropriate when there is reason to believe that the IRS is not administering the tax law consistently

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IRS Administrative Powers(slide 1 of 3)

• Examination of records
– The IRS can examine a taxpayer’s records to determine the correct tax due
• Burden of proof
– If taxpayer meets the record keeping requirement and substantiates income and deductions properly, the IRS bears the burden of proof in establishing a tax deficiency during litigation

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IRS Administrative Powers (slide 2 of 3)

• Assessment and demand
– The IRS can assess a tax deficiency and demand payment of a tax
– The assessment cannot be made until 90 days after a “statutory notice of deficiency” is issued to the taxpayer
• During the “90 day letter” period, taxpayer may file a petition with the U.S. Tax court, which prevents the IRS from collecting the amount until after the Tax Court case is resolved
• After assessment the IRS demands payment

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IRS Administrative Powers(slide 3 of 3)

• IRS collection procedures
– If the taxpayer does not pay an assessed tax, the IRS can place a lien on all property belonging to the taxpayer
– The IRS can garnish (attach) wages and salary and seize and sell all nonexempt property by any means
• A taxpayer’s principal residence is exempt from the levy process, unless
– The disputed tax, interest, and penalty exceed $5,000 and
– A U.S. District Court judge approves of the seizure

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IRS Audit Selection(slide 1 of 2)

• The IRS does not disclose its audit selection process
• Utilizes mathematical formulas to select returns:
– Likely to contain errors and
– Yield a substantial amount of additional tax revenue
• Most audits of individual tax returns are started about two years following the date the return is filed

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IRS Audit Selection (slide 2 of 2)

• Examples of audit selection
– Certain taxpayers are more likely to be audited such as:
• Individuals with gross income > $200,000
• Self-employed individuals with substantial business income and deductions
• Cash businesses where potential for evasion is high

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Types of IRS Audits(slide 1 of 3)

• Correspondence audits
– The return is checked for mathematical accuracy or clearly erroneous deductions, etc. soon after the return is filed
– In addition, several months after filing, all 1099s and W-2s and other matching information is verified
– If a discrepancy is found in either of these cases, the IRS simply sends the taxpayer an explanatory letter and a bill or a refund

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Types of IRS Audits (slide 2 of 3)

• Office audits
– These audits are frequently limited in scope, and can be conducted in the IRS office
– The taxpayer is generally asked to substantiate the items requested (i.e., present invoices, canceled checks, etc.)

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Types of IRS Audits (slide 3 of 3)

• Field audits
– Commonly used for corporate returns and for returns of individuals engaged in business or professional activities
– These audits are generally conducted at a taxpayer’s home or business

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Audit Procedures (slide 1 of 4)

• Prior to or at the initial interview, the IRS must
– Provide the taxpayer with an explanation of the audit process and
– Describe the taxpayer’s rights under that process
• IRS representative must suspend the interview if the taxpayer clearly states a desire to consult an attorney, CPA, or enrolled agent

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Audit Procedures (slide 2 of 4)

The IRS must grant permission to make an audio recording of any interview, upon advance request
On completion of the examination, the IRS agent will file a Revenue Agent’s Report (RAR) outlining recommended changes to the return (if any)

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Audit Procedures (slide 3 of 4)

• The RAR is reviewed internally before the IRS assesses an additional tax
• The taxpayer may accept the RAR or appeal within the IRS
• Appeal within the IRS must be accompanied by a written protest unless:
– The amount of tax does not exceed $10,000 for any tax year
– The adjustment resulted from a correspondence or office audit

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Audit Procedures (slide 4 of 4)

Settlement with an IRS agent is based solely on the merits of the case, given IRS policy
Settlement at the IRS appeals level can be based on the “hazards of litigation” - i.e., the likelihood that the courts would agree with the IRS position

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Offers in Compromise and Closing Agreements(slide 1 of 2)

• Offers in compromise
– IRS can negotiate a compromise if taxpayer’s ability to pay the tax is doubtful
– May result in IRS accepting less than full amount of tax due
• Final payment of taxes may be allowed through installment payments

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Offers in Compromise and Closing Agreements(slide 2 of 2)

• Closing agreements
– May be used:
• When disputed issues carry over to future years
• To dispose of a dispute involving a specific issue in a prior year or a proposed transaction involving future years
– Binding on taxpayer and IRS

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Interest(slide 1 of 3)

• Congress sets interest rates applicable to underpayments and overpayments of tax
– Rate is determined quarterly
– Based on federal short-term rates
• For noncorporate taxpayers
– The interest rate for both over-and underpayments is 4% for the first quarter of 2018
• For most corporate taxpayers
– The rate is 3% for overpayments and 4% for underpayments

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Interest (slide 2 of 3)

• IRS deficiency assessments
– Interest usually accrues from unextended due date of return until 30 days after taxpayer agrees to the deficiency by signing Form 870
– If amount due is not paid within 30 days interest again accrues on the deficiency

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Interest (slide 3 of 3)

• Refund of taxpayer’s overpayments – If refunded within 45 days after return is filed or is due, no interest is allowed – If taxpayer files an amended return or a claim for a refund of a prior year’s tax, interest is accrued from the original due date of the return • Even then, no interest accrues until a return is filed or, if the return has been filed, if the IRS pays the refund within 45 days

Taxpayer Penalties (slide 1 of 11)

• A comprehensive array of penalties are used to promote compliance with the tax law • Failure to file a tax return – Penalty is 5% per month (up to 25%) on amount of tax due • Minimum penalty is $210 – If failure is due to fraud, rate is 15% per month (up to 75%)

Taxpayer Penalties (slide 2 of 11)

• Failure to pay tax due – Penalty is 1/2% per month (up to 25%) on amount of tax due – If failure is after notice of deficiency is received, rate is 1% per month • Both above penalties can be eliminated if reasonable cause exists for failure to file or pay – Failure to file penalty is reduced by any failure to pay penalty for the same month

The IRS Commissioner has organized the day-to-day activities of the agency into four major operating divisions, based on the type of tax returns to be processed. True/False

True

The Chief Counsel's office provides legal advice to the IRS and guidance to the public on matters pertaining to the administration and enforcement of the tax laws. True/False

True

The IRS Commissioner represents the IRS in all litigation before the Tax Court. True/False

False

Taxpayers usually are able to settle routine tax disputes (e.g., queries involving the documentation of deductions) through _____ with the IRS. However, _____ are conducted in an office of the IRS. In most instances, the taxpayer is subject to _____. A _____is conducted by IRS agents at the office or home of the taxpayer or at the office of the taxpayer's representative.

- a correspondence audit - office audits - substantiate only a few items on the return - field audit

Redford, a calendar year taxpayer, files his 2017 return on September 15, 2018. The return reflects an overwithholding of $890. On March 1, 2019, Redford receives a refund of his 2017 overpayment. Interest on the refund began to accrue on _____.

September 15, 2018.

There are no minimum education or experience requirements for those who are paid to file Federal tax returns for others. True/False

True

Upon receiving a PTIN, the tax professional can refer to himself or herself as a "registered tax return preparer." True/False

True

Holding a PTIN authorizes the tax preparer to carry out tax planning services. True/False

False

A settlement agreement offered by the IRS in a tax dispute, especially where there is doubt as to the collectibility of the full deficiency.

Offer in compromise

This notice is sent to a taxpayer upon request, upon the expiration of the 30-day letter, or upon exhaustion by the taxpayer of his or her administrative remedies before the IRS.

Ninety-day letter

Provisions of the law that specify the maximum period of time in which action may be taken concerning a past event.

Statute of limitations

Relief from taxpayer and preparer penalties often is allowed where there is belief that the taxpayer's actions are in good faith.

Reasonable cause

Reflects any adjustments as a result of an audit of the taxpayer. It is mailed to the taxpayer along with the 30-day letter, which outlines the appellate procedures available to the taxpayer.

Revenue Agent's Report

The written response of the IRS to a taxpayer’s request for interpretation of the revenue laws with respect to a proposed transaction (e.g., concerning the tax-free status of a reorganization). Not to be relied on as precedent by other than the party who requested the ruling.

letter ruling

Upon the request of a taxpayer, the IRS will comment on the tax status of a completed transaction. Determination letters frequently are used to determine whether a retirement or profit sharing plan qualifies under the Code and to determine the tax-exempt status of certain nonprofit organizations.

determination letter

Definition: TAMs are issued by the IRS in response to questions raised by IRS field personnel during audits. They deal with completed rather than proposed transactions and are often requested for questions related to exempt organizations and employee plans.

technical advice memorandum (TAM)

An IRS initiative that offers special rewards to informants who provide evidence regarding tax evasion activities of businesses or high-income individuals. More than $2 million of tax, interest, and penalty must be at stake. The reward can reach 30 percent of the tax recovery that is attributable to the whistleblower’s information.

Whistleblower Program

A Revenue Agent’s Report (RAR) reflects any adjustments made by the agent as a result of an audit of the taxpayer. The RAR is mailed to the taxpayer along with the 30-day letter, which outlines the appellate procedures available to the taxpayer.

Revenue Agent's Report (RAR)

A letter that accompanies an RAR (Revenue Agent’s Report) issued as a result of an IRS audit of a taxpayer (or the rejection of a taxpayer’s claim for refund). The letter outlines the taxpayer’s appeal procedure before the IRS. If the taxpayer does not request any such procedures within the 30-day period, the IRS issues a statutory notice of deficiency (the 90-day letter).

30-day letter

This notice is sent to a taxpayer upon request, upon the expiration of the 30-day letter, or upon exhaustion by the taxpayer of his or her administrative remedies before the IRS. The notice gives the taxpayer 90 days in which to file a petition with the U.S. Tax Court. If a petition is not filed, the IRS will demand payment of the assessed deficiency. §§ 6211–6216.

90-day letter

A settlement agreement offered by the IRS in a tax dispute, especially where there is doubt as to the collectibility of the full deficiency. Offers in compromise can include installment payment schedules as well as reductions in the tax and penalties owed by the taxpayer.

offer in compromise

In a tax dispute, the parties sign a closing agreement to spell out the terms under which the matters are settled. The agreement is binding on both the Service and the taxpayer.

closing agreement

Relief from taxpayer and preparer penalties often is allowed where reasonable cause is found for the taxpayer’s actions. For example, reasonable cause for the late filing of a tax return might be a flood that damaged the taxpayer’s record-keeping systems and made a timely completion of the return difficult.

reasonable cause

Major civil taxpayer penalties relating to the accuracy of tax return data, including misstatements stemming from taxpayer negligence and improper valuation of income and deductions, are coordinated under this umbrella term. The penalty usually equals 20 percent of the understated tax liability.

accuracy-related penalties

Failure to exercise the reasonable or ordinary degree of care of a prudent person in a situation that results in harm or damage to another. A penalty is assessed on taxpayers who exhibit negligence or intentional disregard of rules and Regulations with respect to the underpayment of certain taxes.

negligence

Taxpayer and tax preparer understatement penalties are waived where substantial authority existed for the disputed position taken on the return.

substantial authority

Tax fraud falls into two categories: civil and criminal. Under civil fraud, the IRS may impose as a penalty an amount equal to as much as 75 percent of the underpayment [§ 6651(f)]. Fines and/or imprisonment are prescribed for conviction of various types of criminal tax fraud (§§ 7201–7207). Both civil and criminal fraud involve a specific intent on the part of the taxpayer to evade the tax; mere negligence is not enough. Criminal fraud requires the additional element of willfulness (i.e., done deliberately and with evil purpose). In practice, it becomes difficult to distinguish between the degree of intent necessary to support criminal, rather than civil, fraud. In either situation, the IRS has the burden of proof to show the taxpayer committed fraud.

fraud

Provisions of the law that specify the maximum period of time in which action may be taken concerning a past event. Code §§ 6501–6504 contain the limitation periods applicable to the IRS for additional assessments, and §§ 6511–6515 relate to refund claims by taxpayers.

statute of limitations

A tax practitioner who has gained admission to practice before the IRS by passing an IRS examination and maintaining a required level of continuing professional education.

enrolled agents (EAs)

A portion of the Federal tax Regulations that describes the levels of conduct at which a tax preparer must operate. Circular 230 dictates, for instance, that a tax preparer may not charge an unconscionable fee or delay the execution of a tax audit with inappropriate delays. Circular 230 requires that there be a reasonable basis for a tax return position and that no frivolous returns be filed.

Circular 230

One who prepares tax returns for compensation. A tax preparer must register with the IRS and receive a special ID number to practice before the IRS and represent taxpayers before the agency in tax audit actions. The conduct of a tax preparer is regulated under Circular 230. Tax preparers also are subject to penalties for inappropriate conduct when working in the tax profession.

Tax preparer

A tax preparer penalty is assessed regarding the understatement of a client’s tax liability due to a tax return position that is found to be too aggressive. The penalty is avoided if there is substantial authority for the position or if the position is disclosed adequately on the tax return. The penalty equals the greater of $1,000 or one-half of the tax preparer’s fee that is traceable to the aggressive position.

unreasonable position

The Chief Counsel's office provides legal advice to the IRS and guidance to the public on matters pertaining to the administration and enforcement of the tax laws. True/False

True

The head of IRS operations is the Commissioner. True/False

True

The IRS responds to a taxpayer request concerning the tax treatment of a completed transaction in a determination letter. True False

True

When a tax issue is taken to court, the burden of proof is on the IRS to show that the items reported on the return are not substantiated. True False

True

If a taxpayer has been audited in a past year and the audit led to the assessment of a substantial deficiency, the IRS often makes a return visit for a later tax year. True False

True

With respect to the audit process, which of the following statements is correct? 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 disclose its audit selection techniques. c. If the taxpayer makes a math error on Form 1040, a correspondence audit automatically is triggered. d. For a Form 1040 that is filed on April 11, 2018, if the taxpayer has not received an audit notification from the IRS by the end of 2018, the return may still be audited. e. All of these choices are correct.

As part of the appeals process: a. If an agreement cannot be reached at the agent level, the taxpayers receives a 30-day letter. b. If an appeal is not requested within the proper time frame, a 90-day letter is issued. c. If a settlement is reached with the Appeals Division, the taxpayer is required to sign Form 870-AD. d. The Appeals Division is authorized to settle all tax disputes based on the hazards of litigation. e. All of these choices are correct.

A closing agreement is always binding on both the taxpayer and the IRS. True False

False

The Federal short-term interest rates are published in Revenue Rulings. True False

True

Congress sets the interest rates applicable to Federal tax underpayments (deficiencies) and overpayments (refunds) close to the rates available in financial markets. True False

True

As a result of undervaluing property transferred by gift, Dan owes additional gift taxes of $3,000. The penalty for undervaluation does not apply in this situation, because the tax understatement was too small. True False

True

Jimmy is six months late filing his tax return. He has taxes due of $800. What is the amount of the penalty imposed on his return? a. $0. b. $200. c. $240. d. $205. e. None of these choices are correct.

D For failure to file a tax return by the due date, a penalty of 5 percent per month is imposed on the amount of tax shown as due on the return. However, this penalty is capped at 25 percent, so "$240" is incorrect ($240 = $800 × 30%). Furthermore, the minimum penalty is $205, so "$200" is incorrect ($200 = $800 × 25%). Jimmy owes the minimum penalty in this instance.

Obtaining an extension for filing a tax return automatically extends the date by which the taxes due must be paid. True False

False

Miguel, an individual calendar year taxpayer, incurred the following transactions: ``` Gross receipts $ 800,000 Less: Cost of sales (300,000) Net business income $ 500,000 Capital gain $ 50,000 Capital loss (90,000) (40,000) Total income $ 460,000 ``` Assuming that any error in timely reporting these amounts was inadvertent, how much omission from gross income would be required before the six-year statute of limitations would apply? a. Six-year rule cannot apply here. b. More than $115,000. c. More than $212,500. d. More than $137,500. e. None of these choices are correct.

C Gross income = Gross receipts + capital gain ($800,000 + $50,000 = $850,000) 25% × $850,000 = $212,500

Which of the following situations applies to a seven-year statute of limitations on additional tax assessments? a. No return at all is filed. b. Taxpayer discovers an inadvertent overstatement of deductions equal to 5 percent of gross income. c. None of these choices are correct. d. Taxpayer inadvertently omits an amount of gross income in excess of 25 percent of the gross income stated on the return. e. All of these choices are correct.

C "No return at all is filed" has no statute of limitations. "Taxpayer inadvertently omits an amount of gross income in excess of 25 percent of the gross income stated on the return" has a six-year statute of limitations.

A statute of limitations defines the period of time during which one party may pursue against another party a cause of action or other suit allowed under the governing law. True False

True

A taxpayer should assess the economic consequences of taking a tax dispute to court. True False

True

Dorothy prepared Olaf's income tax returns for no compensation for 2016 and 2015. Dorothy is Olaf's cousin. In 2019, the IRS notifies Olaf that it will audit his returns for 2015–2017. If Olaf so desires, Dorothy may represent him during the audit of all three returns. True False

False

Judith and Harold Simmons are in the midst of negotiating a divorce. Because both parties are unwilling to share any current financial information, their joint Form 1040 for 2018 is not filed until October 31, 2019, when their respective divorce attorneys forced them to cooperate. The Simmonses should not be subject to any Federal late-filing penalties, because of the reasonable cause exception. True False

False

During any month in which both the failure to file penalty and the failure to pay penalty apply, the failure to file penalty is increased by the amount of the failure to pay penalty. True False

False The failure to file penalty is decreased by the amount of the failure to pay penalty.

Reuben (a calendar year taxpayer) donates a coin collection to a local civil war museum (a qualified charity). The coin collection cost Reuben $2,000 ten years ago and, according to one of Reuben's friends (an amateur artist), is worth $50,000. On his income tax return, Reuben deducts $50,000 as a charitable contribution. Upon later audit by the IRS, it is determined that the true value of the coin collection was $30,000. Assuming that Reuben is subject to a 32 percent marginal income tax rate, his penalty for overvaluation is: a. $6,000. b. $0. c. $2,560. d. $1,280. e. $5,000.

D Reuben's penalty for overvaluation is $1,280 [20% (penalty tax due to overvaluation) × $6,400 (the additional tax for using $50,000, and not $30,000)].

In the typical year, the IRS assesses about 40 million penalties, totaling almost _____ in payments. a. $15 billion. b. $1 billion. c. $100 million. d. $500 million. e. $5 billion.

Montana, a calendar year taxpayer subject to a 35 percent marginal tax rate, claimed a charitable contribution deduction of $500,000 for a sculpture that the IRS later valued at $150,000. The applicable overvaluation penalty is: a. $24,500. b. $10,000 (maximum penalty). c. $122,500. d. $49,000. e. None of these choices are correct.

Which of the following constitutes a reasonable cause for failure to file a tax return? a. Not knowing when the tax return was due. b. Delegating the filing of the tax to a professional accountant. c. Coming down with the flu. d. Refusal of the taxpayer's spouse to cooperate on the filing of a joint return. e. None of these choices are correct.

E The courts have ruled that no reasonable cause is found where the taxpayer delegated the filing task to another, even when that person was an accountant or an attorney. Other reasons not qualifying as reasonable cause include lack of information on the due date of the return, illness that did not incapacitate a taxpayer from completing a return, refusal of the taxpayer's spouse to cooperate for a joint return, and ignorance or misunderstanding of the tax law.

Fiona, a calendar year taxpayer, did not file a tax return for 2011 because she honestly believed that no additional tax was due. In 2019, Fiona is audited by the IRS and the agent assesses a deficiency of $7,000 for tax year 2011. Fiona need not pay this deficiency, since the statute of limitations expired on April 15, 2015. True False

False The statute of limitations never expires if no return has been filed.

A statute of limitations defines the period of time during which one party may pursue against another party a cause of action or other suit allowed under the governing law. True False

True

The statute of limitations never expires if no return has been filed. True False

true

A seven-year statute of limitations on additional tax assessments applies in which of the following situations? a. An investment in a marketable security is worthless. b. Taxpayer discovers an inadvertent overstatement of deductions equal to 5 percent of gross income. c. No return at all is filed. d. Taxpayer inadvertently omits an amount of gross income in excess of 25 percent of the gross income stated on the return. e. All of these choices are correct.

A "No return at all is filed" has no statute of limitations. "An investment in a marketable security is worthless" has a seven-year statute of limitations. "Taxpayer inadvertently omits an amount of gross income in excess of 25 percent of the gross income stated on the return" has a six-year statute of limitations.

For individuals, an amended return is filed on Form 1040X. True False

True

A technical advice memorandum (TAM) is issued by the National Office only to large corporations. True False

False A TAM is issued by the National Office to IRS personnel in response to a specific request by an agent, Appellate Conferee, or IRS executive.

As part of the assessment and collection procedures of the IRS: a. In a jeopardy assessment, the taxpayer is given ten days to pay the tax. b. The levy power of the IRS allows it to garnish the wages of the taxpayer. c. The taxpayer is given twenty days to pay the tax after the demand for payment is issued. d. The taxpayer's principal residence is exempt from all levy proceedings. e. All of these choices are correct.

b The levy power of the IRS is very broad. It allows the IRS to garnish wages and salary and to seize and sell all nonexempt property by any means.

As part of the assessment and collection procedures of the IRS: a. The taxpayer's principal residence is exempt from all levy proceedings. b. The taxpayer is given twenty days to pay the tax after the demand for payment is issued. c. In a jeopardy assessment, the taxpayer is given ten days to pay the tax. d. The levy power of the IRS allows it to garnish the wages of the taxpayer. e. All of these choices are correct.

All taxpayers who owe less than $50,000 are guaranteed the right to use the installment agreement to pay their taxes. True False

False . An individual who has filed timely tax returns for five years is guaranteed the right to use an installment agreement when the amount in dispute does not exceed $10,000.

The IRS can negotiate a compromise if the taxpayer's ability to pay a delinquent tax is doubtful. True False

True An offer in compromise is appropriate if there is doubt as to the taxpayer's liability for the tax, the IRS's ability to collect the tax, or the taxpayer's ability to pay the tax without suffering significant economic hardship.