FP514 Module 8

Question 1

fyi
PROFESSOR’S NOTE
Congress delegates rule-making authority to the U.S. Department of Treasury. Treasury Regulations are the Department’s official interpretation of the Internal Revenue Code. Next to the Code itself, Treasury Regulations are the highest source of authority in matters of federal income tax law

Question 2

fyi

Tax Law Doctrines - IRS opinion of proper tax management versus abusive tax planning
Business purpose doctrine
Transaction not effective for income tax purposes unless intended to achieve genuine business purpose other than tax avoidanc

Question 3

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Tax Law Doctrines
Assignment of income doctrine - income is taxed to the person who earns it or owns the property that produces it - even if they try to give it away.
“Fruit of the tree”

Tax benefit rule or doctrine - if you got tax break before ,and you get the money back later, you have to pay tax on it.
Converts otherwise nontaxable receipts into taxable income.

Question 4

Tax Law—Question
Which of the following are the sources of federal tax law?
A. Treasury regulations
B. Tax newsletters
C. The mainstream media
D. Executive orders

Answer 4

A

The Internal Revenue Code and Treasury regulations are the primary sources of all tax law.

Question 5

fyi

Purpose of Federal Tax Law

 raising revenue
 economic growth and development
 price stability

Question 6

fyi

For long-term treatment, holding period must be greater than 12 months (12 months and 1 day)

REIT dividends:
 Individual taxpayers can deduct 20% of ordinary REIT dividends with no phase out limitations
(TCJA).
 However, REIT Dividends that qualify for the long term capital gain rates do not also qualify for
the 20 percent QBI deduction.

Question 7

fyi

Basic Tax Management Techniques
Treasury bills, notes, and bonds
 Interest subject to federal income tax but exempt from income tax levied by state or local government
Use of credits and deductions
 Tax credits advantageous for low-bracket taxpayers
 Tax deductions advantageous for high-bracket taxpayers

Question 8

Tax Management—Question
Jenna is in a meeting with her financial planner. She is 30 and has just been promoted to a position where
she is compensated in the six figures. Income tax liability has suddenly become an important concern. Her
adviser has been explaining various methods of avoiding, deferring, and minimizing her income tax
exposure. Investing in a Section 401(k) retirement plan and municipal bonds are examples of what forms
of the tax management of federal income tax liabilities?
I. Deferral
II. Avoidance
III. Conversion to capital gain income
IV. Conversion to tax-exempt income
A. I, II, III, and IV
B. I and IV
C. II only
D. II and III

Answer 8

a
Statements I, II, III, and IV are correct. Investing in a Section 401(k) retirement plan is an example of an income tax deferralmanagement technique.
Distributions from this plan are taxable as ordinary income (not capital gains) and are not tax exempt. The interest earned on the municipal bond
avoids federal income tax and, upon a sale of the bond, any gain on the sale is taxable as a capital gain if held long-term.

Question 9

fyi

Three types of IRS tax audits include the following:
Correspondence audit - done by mail - less serious - narrow scope.
Office audit - in person meeting at IRS office - broader than correspondence
Field audit - most serious - agent comes to office or home

Question 10

fyi

who’s allowed to represent clients Before the IRS
Attorneys
CPAs
Enrolled agents
Enrolled actuaries
CFP®certificants NOT eligible without additional credentials

Question 11

fyi

Constructive Receipt Income Rule or Doctrine - Income taxed as though it had actually been received
Constructive receipt
 If no substantial limitation on taxpayer’s right to bring funds within the taxpayer’s control
Example: Payroll check issued December 31 and available for pick up by employee on that date considered income for that year

Question 12

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Filing Requirements
Factors determining whether income tax return is required:
Gross income
Filing status
Age

Question 13

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Filing Requirements
 MFJ is not required to file unless combined gross income is greater than or equal to basic standard deduction.
 MFS must file if income is greater than or equal to the standard deduction amount

Question 14

fyi

Filing Requirements
 Return due date
 IRS Form 1040
Fifteenth day of fourth month after end of tax year (April 15)
 If date falls on weekend or holiday, return is due on next business day
 Six-month extension (to October 15) of time to file (not to pay) may be requested on IRS Form 4868
Usually granted, absent egregious circumstances
 S corporations must file by 15th day of third month following end of corporate tax year
 Partnerships must file Form 1065 by the first March 15 following the close of the partnership’s tax year.

Question 15

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Interest and Penalties
Interest on underpayments (or overpayments) runs from unextended due date of return

Question 16

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Interest and Penalties
Penalties
 The failure-to-file (FTF) penalty is 5% per month (or partial month), up to 25% maximum.
If a return is filed more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $525 or 100% of unpaid tax.
 The failure-to-pay (FTP) penalty is 0.5% per month (or partial month), up to a 25% (or 50 months) maximum.
 If both FTF and FTP penalties are assessed, the FTF penalty is reduced by
the FTP penalty

Question 17

Interest and Penalties—Example
A taxpayer files her tax return 39 days after the due date. Along with the filing of the return,
she remits a check for $6,000, which is the balance of the tax owed. Therefore, the total FTF
and FTP penalties are $600, computed as follows:

FTP penalty (0.5% ×$6,000 ×2) $ 60
FTF penalty (5% ×$6,000 ×2) + 600
FTP penalty (penalties run concurrently) – 60
Total penalties (FTF and FTP) $ 600
The FTF penalty of $600 is reduced by the FTP penalty of $60, making the adjusted FTF penalty $540. Then, adding the FTP penalty of $60 (still due even though it reduces the FTF penalty) makes up the total assessed penalties of $600 ($540 + $60)

Question 18

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Interest and Penalties
Underpayment penalties in order of severity
Criminal fraud: tax evasion, which is illegal
If convicted, the taxpayer is subject to heavy (court-determined) fines, imprisonment , or both.

Civil fraud: taxpayer fraud that does not rise to level of criminal fraud
The penalty is 75% of the portion of the underpayment attributable to fraud.

Negligence: accuracy-related
The penalty is 20% of the portion of the underpayment attributable to
negligence.

Frivolous return
The penalty is $5,000 for each frivolous return filed.

Question 19

Penalty—Question
Chet files a timely tax return but is later required to pay an additional
$15,000 in tax. Of this amount, $6,000 is attributable to the taxpayer’s
negligence. The negligence penalty will be
A. $525 because there is a maximum penalty of $525.
B. $1,200 because a 20% penalty is applied to the $6,000 underpayment.
C. $1,800 because a 30% penalty is applied to the $6,000 underpayment.
D. $3,000 because a 20% penalty is applied to all tax due.

Answer 19

b

A 20% penalty applies to the negligence component; therefore, the total amount of penalty
imposed on Chet is $1,200 ($6,000 ×0.20).

Question 20

Paul was recently assessed a deficiency of $10,000, along with interest of $2,000, from a prior year’s tax return. It has been determined that the deficiency was due to civil fraud. What is the amount of the fraud penalty?

A)
$6,000

B)
$2,000

C)
$10,000

D)
$7,500

Answer 20

D

Explanation
Civil fraud, essentially, is taxpayer fraud that does not rise to the level of criminal fraud. If imposed, the penalty is 75% of the portion of tax underpayment attributable to fraud. In this case, the fraud penalty is $7,500 (75% of $10,000). The $2,000 from a prior year’s return would be separate from the fraud penalty.

LO 8.2.3

Question 21

Which one of the following are IRS statements reflecting the internal management practices of the IRS that affect the rights and duties of taxpayers?

A)
Regulations

B)
Private Letter Rulings

C)
Revenue Rulings

D)
Revenue Procedures

Answer 21

d

Question 22

Disclosing or using client information given to a tax preparer may result in which one of the following maximum penalties?

A)
Imprisonment for up to one year

B)
Closure of business

C)
50% tax penalty

D)
100% penalty

Answer 22

a

Question 23

If an employer withholds Social Security and federal income taxes from employee paychecks, but fails to pay those amounts to the IRS, what is the percentage penalty that is imposed?

A)
100%

B)
50%

C)
75%

D)
25%

Answer 23

a

Question 24

Which one of the following is NOT an economic substance doctrine?

A)
Assignment of income doctrine

B)
Step transaction doctrine

C)
Comparative income doctrine

D)
Substance over form doctrine

Answer 24

C

Question 25

Which one of the following amendments to the U.S. Constitution established federal taxation in the U.S.? A) Seventeenth Amendment B) Sixteenth Amendment C) Eighteenth Amendment D) Fifteenth Amendment

Answer 25

B

Question 26

If a court disallows a loss on the sale of an asset because the sale was not bona fide and was made for the sole purpose of realizing a loss, the court is applying A) the step transaction doctrine. B) the assignment of income doctrine. C) the clear reflection of income doctrine. D) the sham transaction doctrine.

Answer 26

D

Question 27

If a taxpayer deducted medical expenses on a prior year's tax return and receives a reimbursement of the expenses from her insurance company in the following year, which one of the following rules or doctrines might cause the reimbursement to be included in income? A) Tax benefit rule B) Ownership attribution rules C) Constructive receipt doctrine D) Assignment of income doctrine

Answer 27

a Explanation The tax benefit rule applies to situations in which a particular tax benefit exists. For instance, if an insurance reimbursement is received for medical expenses, it is generally nontaxable. However, if the reimbursement was received in the year after a medical expense deduction was taken and a tax benefit was received for that deduction, then the reimbursement is converted into taxable income in that subsequent year. LO 8.2.3

Question 28

Mary filed her 2024 income tax return on April 3, 2025. The IRS has recently determined that she worked a part-time job, but the employer failed to provide Mary with a W-2. Mary honestly did not realize that she was required to report the income because she did not receive a W-2. The IRS has determined that her negligent failure to report the income resulted in an additional income tax liability of $2,000. What is Mary's tax penalty? A) $100 B) $400 C) $200 D) $1,000

Answer 28

b Explanation The negligence penalty is 20% of the deficiency due to the taxpayer's negligence. For the $2,000 tax deficiency, 20% results in a negligence penalty of $400. It may be argued that the failure to report the income was fraud, but the fact pattern states that the act was merely negligent. LO 8.2.2

Question 29

Which one of the following is a federal taxation function of the social objective? A) Reduction of taxes during a recession to stimulate the economy B) Promoting full employment C) Charitable deduction D) Restricting spending through greater taxation

Answer 29

c Explanation The reduction of taxes in order to stimulate the economy is due to the economic objective, as well as restricting spending and promoting full employment. Social objectives of the federal taxation system include the charitable deduction, excluding life insurance proceeds from taxation, and renovation of a historic home.

Question 30

Which one of the following is a statute of limitations that restricts the IRS in auditing a return? A) Six years if 25% of gross income is unreported B) Seven years from the filing date of the return or due date, if later C) Ten years for failure to file or if a fraudulent return is filed D) Twelve years if 50% of gross income is unreported

Answer 30

A * 3 yrs from filing date or due date (the latest) * 6yrs over 25% of gross income is omitted * no time limit for fraudulent return or failure to file ** 7 yrs does not exist...no such rule...common CFP distractor