Professional Accounting Research
1st Power Point
• Introduction to Professional Research
• Tax Research
– PAK chapter 1, pp. 1-1 to 1-7
• Ethics
• Tax Shelters
– Coltec, 2006-2 USTC ¶50,389, 454 F3d 1340
– Wal Mart, 12/31/2007, NC Superior Court
Research & Accounting
• need for critical thinking
• need for judgment
– principal-based versus rules-based financial
accounting
– tax avoidance versus tax evasion
• too much authoritative literature
• important to be able to communicate results
Research & CPA Exam
• CONTENT AND SKILL SPECIFICATIONS FOR THE
UNIFORM CPA EXAMINATION (approved May 15,
2009, effective Jan. 1, 2011)
• Application of the Body of Knowledge (40-50% of FAR,
REG, AUD) including:
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–
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–
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analysis
judgment
synthesis
evaluation
research
“Higher-level cognitive skills that require individuals to act or transform
knowledge in some fashion. These skills are inextricably intertwined
and thus are grouped into this single skill area.”
Research & CPA Exam (con’t)
• Research:
– Identify the appropriate research question.
– Identify key search terms for use in performing
electronic searches through large volumes of data.
– Search through large volumes of electronic data to find
required information.
– Organize information or data from multiple sources.
– Integrate diverse sources of information to reach
conclusions or make decisions.
– Identify the appropriate authoritative guidance in
applicable financial reporting frameworks and auditing
standards for the accounting issue being evaluated.
From The Uniform CPA Examination Alert Spring 2009
What is your focus in seeking new ways to assess research skills?
We are now developing research tasks that involve not only searching
authoritative literature, but also making use of the findings. At the time
CBT was launched in 2004, not all students were being instructed in
research skills as part of their curricula. This has now changed. Research
courses are available at many institutions. In our national survey of entrylevel practice last year, we recognized that the time has come to expand the
testing of research skills. We are also using content experts to guide us in
identifying the ways in which entry-level practitioners are finding and
using information. This is leading us to explore research topics outside the
scope of authoritative literature. We plan to field-test this type of research
task with students in accounting programs. If successfully tested, we could
introduce research tasks that rely on alternative databases, exhibits and
resources. Our consideration of other sources reflects the recognition that
CPAs must often rely on a variety of information and data sources. Some
of the resources we have been exploring include Thomas, the Library of
Congress record of legislation, the U.S. Tax Court database of tax court
rulings, and information databases, such as financial reports submitted to
the SEC in XBRL format. No decisions have as yet been made concerning
these resources but their use is being explored.
• http://www.cpa-exam.org/
Research Steps
1. identify the relevant facts and issues
2. locate authority and collect the evidence
3. analyze the results and identify the
alternatives
4. develop conclusions and recommendations
5. communicate the results and
recommendations
Tax Research - Why taxes?
• governments need revenue to support their
activities
• taxes can be a major source of revenue
• revenue <=> government spending
– = balanced budget
– > surplus
– < deficit
What to tax? What rate to use?
• tax base X tax rate = tax
• tax base
– amount to which tax rate is applied
– what to include or exclude?
– base broadening - more income included
• tax rate
– proportional, progressive or regressive
Criteria used to select a tax structure
• Adam Smith - 18th century
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equality
convenience
certainty
economy
• factors influencing current tax structure
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economic
social
equity
political
Tax Formula
Income(broadly conceived)
Less: Exclusions
Gross Income
Less: Deductions for AGI
Adjusted Gross Income (AGI)
Deductions from AGI:
Less: > of itemized deductions
or standard deduction
Less: Personal & dependency exemptions
Taxable Income
$x,xxx
(x,xxx)
$x,xxx
(x,xxx)
$x,xxx
(x,xxx)
(x,xxx)
______
$x,xxx
Elements of Tax Practice
• Tax Practice for a CPA
– Tax Compliance
• preparing tax returns
– Tax Research
• attempting to answer tax questions
– Tax Planning
• arranging ones affairs to optimize tax liabilities
• Tax Litigation
– generally handled by lawyers
Tax Research by CPAs
• “unauthorized practice of law”
– sometimes difficult to determine
• a CPA should probably not provide the
following types of general legal services
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–
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–
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expressing a legal opinion on any nontax matter
drafting wills and trust instruments
drafting contracts
drafting incorporation papers
drafting partnership agreements
Tax Planning
• Consider social, economic, and business goals as well as
tax motives
• Tax avoidance
– the legal minimization of tax liabilities and one goal of tax
planning
• Tax evasion
– the illegal minimization of tax liabilities and can lead to fines
and jail
• Abusive tax avoidance
– a transaction, or series of transactions, created for the sole
purpose of avoiding taxes. Unlike other tax avoidance,
abusive tax avoidance often uses “multi-layer transactions
for the purpose of concealing the true nature and ownership
of the taxable income and/or assets.” (IRS)
Tax Planning (con’t)
• open transactions
– transaction not yet completed so modifications
can be made prior to completing
• closed transactions
– transaction already completed so have to plan
within the constraints of what is already done
• also already filed transaction that is being audited
Show me someone who doesn’t
think accounting is a creative
profession and I will show you
someone who does their own
taxes.
Over and over again, courts
have said that there is
nothing sinister in so
arranging one’s affairs as to
keep taxes as low as possible.
Judge Learned Hand
The difference between tax
avoidance and tax evasion is the
thickness of a prison wall.
Denis Healy, a former British Chancellor
Ethics for Tax Professionals
• IRS Circular 230
– all who practice before the IRS
• more later in semester
• Sarbanes-Oxley and Taxation
– more later in semester
• American Institute of Certified Public Accountants
(AICPA) Code of Professional Conduct & Statements of
Standards for Tax Service
– for CPAs who are members of the AICPA
– also states have ethics guidelines
• more later in semester
Ethics More Generally
• Morality
– Is a little tax evasion ok?
• a continuum of interpretations
• some examples
– not reporting a small amount of income from working
» babysitting & lawn mowing
– not paying Use Tax to North Carolina
» North Carolina Individual Income Tax Return line 17
» see example
• Social Responsibility
– good for society
– is reincorporating in a tax haven country unpatriotic?
• Stanley Tool
– moving jobs out of the U.S.
• V F Corporation – 95% of products come from non US sources
– 30 North American Manufacturing plants closed
Tax Shelters
• estimated that $10 billion of taxes evaded annually
by improper or questionable tax programs
• Large CPA firms (and others) sell to clients
– “tax investment strategy” (KPMG) or tax products
• When does tax planning become a tax shelter?
– IRS provides a specific definition of when an activity is
a tax shelter and therefore has disclosure requirements
– more generally when does an activity violate ethical
standards of conduct
• abusive tax shelter
– no economic substance
» no business purpose
» see Coltec and Wal Mart
– substance over form
» sham transactions
Tax Shelters & Large CPA firms
• Arthur Andersen & Enron
– 881 offshore subsidiaries to shelter income
• Ernst & Young
– helped Sprint executives shelter income from
stock options
• KPMG & First Union
– helped client shelter income from selling a mall
in Asheville, NC
• KPMG fine & settlement
Cracking Down on Tax Shelters
• Reporting Requirements & Penalties
– enacted in the American Jobs Creation Act of 2004
• Reportable Transactions
– transactions the IRS has identified as having potential
for tax avoidance or evasion
• broader than what might be considered a tax shelter
• report on Form 8886
– include (detailed definitions not required):
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•
•
•
•
•
listed transactions (on IRS website)
confidential transactions
transactions with contractual protection
loss transactions
transactions with significant book-tax differences
transactions involving brief asset holding period
Cracking Down on Tax Shelters
• Material Advisors
– provides material aid, assistance, or advice wrt organizing,
managing, promoting, selling, implementing, insuring, or carrying
out any reportable transaction
– derives gross income, directly or indirectly, in excess of specified
threshold from activity
• threshold = $50,000 when provided to individuals
• threshold = $250,000 in all other cases
• if Material Advisor
– provide a return identifying and describing reportable transaction
• From 8918
• penalty for not complying
– $50,000 for reportable transaction that is not a listed transaction
– > of $200,000 or 50% of gross income for listed transaction
– also must maintain a list of advisees and the list make available to
the IRS
• penalty of $10,000 / day starts 21 days after list requested
• lawyers and accountants arguing privilege applies
Cracking Down on Tax Shelters
• Taxpayers
– penalty for failure to include reportable transaction
information with return
• reportable transaction that is not a listed transaction
– $10,000 for individuals
– $50,000 for all others
• listed transaction
– $100,000 for individuals
– $200,000 for all others
– additional penalty if understatement of tax related to
reportable transactions
• penalty is 20% of understatement
• penalty increases to 30% if transaction not disclosed (as
required)
Tax Planning & Research
(2nd Power Point)
• Research Process
– 5 or 6 steps
• Example of memo posted on Blackboard
• PAK
– corporate ch. 1, pp. 1-2 to 1-6
– Appendix A
Research Steps
1.
2.
3.
4.
5.
Identify the relevant
facts and issues
Locate authority and
collect the evidence
Analyze the results
and identify the
alternatives
Develop conclusions
and recommendations
Communicate the
results and
recommendations
1.
2.
3.
4.
5.
6.
Determine the facts
Identify the issues
Locate applicable
authority
Evaluate authorities
Analyze the facts in
terms of applicable
authority
Communicate
conclusions and
recommendations
Step 1 – Identify Relevant Facts &
Issues
• What is client’s factual situation?
– listening
– learning what to ask
– ask more questions as research process
progresses (iterative process)
– both tax and nontax considerations
Step 1 – Identify Relevant Facts &
Issues (con’t)
• Based on the facts, what are the important
questions that need to be answered?
– a broad question may lead to several narrower
questions
– fact versus law issues
• diamond necklace as gift or compensation
– Gifts are excluded from taxable income (sec. 102)
– Compensation for services are taxable (sec. 61)
– dependency example
CAN I TAKE MY SON WHO IS
AWAY AT COLLEGE AS A
DEPENDENT FOR 2009?
For Electronic Research
1. State the Issue as a Question
2. Identify the Keywords
•
•
important to the question
unique enough to narrow search
3. Construct a Research Query
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•
•
using connectors (Boolean)
using wildcards
exact phrase
Example
A self-employed attorney incurs substantial
business-related travel expenses during the
year. If she buys airline tickets in advance
and stays over a Saturday night, she can
often receive a substantial savings on
airfare. Usually, an extra day of meals and
lodging is less costly than buying the more
expense airline ticket. In the current year,
she has spent $4,000 in extra Saturday night
expenses to save $12,000 in airfare.
Example (con’t)
Are the additional travel costs (primarily meals and
lodging) of staying over a Saturday night in order
to save substantial amounts on the business airfare
deductible?
• key words
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–
–
–
–
travel
meals and lodging
Saturday
airfare
deductible
Step 2 – Locate Authority & Collect
Evidence
• primary authority
– statutory
– administrative
– judicial
• secondary authority
– tax commentary
• provided as part of electronic resources
– tax journals
– textbooks
Primary vs Precedent
• primary authority defined
– “An element of the Federal tax law that was
issued by Congress, the Treasury or Internal
Revenue Service, or a Federal court, and thus
carries greater precedential weight than
elements of the tax law issued by other parties.”
• there are some primary authorities that provide no
precedential value
• Small Cases Division decisions (cited as T.C.
Summary Opinions) cannot be used as
precedents when dealing with the IRS.
“substantial authority”
• IRC § 6662 requires for tax positions taken
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code
proposed, temporary and final regulations
court cases
administrative pronouncements
tax treaties
committee reports (for congressional intent)
private letter rulings
technical advice memoranda
actions on decision
general counsel memoranda
other items published by IRS in Internal Revenue
Bulletin
Primary vs Precedent vs Substantial
Authority
• substantial authority
– IRC § 6662 imposes a penalty on substantial
understatements of tax except where the
taxpayer has “substantial authority” for the
position taken on the return.
• the Regulations for § 6662 specify the sources of
“substantial authority”
– might include items that do not provide precedent
• Letter Rulings are a source of substantial authority
but do not provide precedent to anyone except the
taxpayer issued to
For Electronic Research
4. Select a Database and Execute the Search
5. Interpret and Refine the Search
Step 3 – Analyze the Results &
Identify Alternatives
• may result in going back to facts, issues and /
or authority
• Determine that the authority appropriate
– Surface features vs structural relation
• within primary authority sources have
different weight
– different precedential value
• some have no precedential value
– Small Cases Division Decisions
– Letter Rulings
» to taxpayer issued to only
“Best” Authority
Surface feature – asset
generating expense
Surface feature - expense
Authority A
Client’s scenario
Authority B
Dog
Dog
Elevator
Dog Food
Dog Food
Electricity
“Best” Authority (con’t)
Surface feature – asset
generating expense
Surface feature - expense
Healthy taxpayer
with no sensory
loss
Client is blind
Taxpayer
with heart
disease
Dog
Dog
Elevator
Dog Food
Dog Food
Electricity
“Best” Authority (con’t)
Healthy TP with
no sensory loss
Blind taxpayer
TP with heart
disease
Surface feature –
asset type
Dog
Dog
Elevator
Surface feature expense
Dog Food
Dog Food
Electricity
Asset used for
pleasure
Asset used to
mitigate medical
condition
Asset used to
mitigate medical
condition
Structural relation
Transfer
appropriate?
Example courtesy of Anne Magro,
George Mason University
NO
YES
Step 4 – Develop Conclusions &
Recommendations
• might have some unresolved issues
• might present alternatives
– especially if dealing with open transaction
– pros and cons of each alternative
– risks associated with alternatives
• have to consider client’s preferences
Step 5 – Communicate the Results &
Recommendations
• written and oral
– can vary in degree of formality
– how uncertain is the outcome?
• tax research memo
– Example on Blackboard
– Example PAK, p. A-6
– http://www2.gsu.edu/~accerl/
IRS Web Site
• http://www.irs.gov
• IRS publications and Tax Forms &
Instructions
Tax Planning & Research (3rd Power Point)
Constitutional & Legislative Sources &
Writing a Memo
• Review of History of U.S. Taxation
– PAK, Individual Ch. 1, pp. 1-2 to 1-3
• Statutory Sources
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PAK, Corporate Ch. 1, pp. 1-7 to 1-9
U.S. Constitution
The Legislative Process
Internal Revenue Code
• Reading the IRC
– Tax Treaties
• Writing
– tax memo examples
History of U.S. Taxation
• 1861 - 65 Civil War
• 1894 Congress imposed an income tax
– Supreme Court – unconstitutional (Pollock 1895)
• 1909 corporate income tax
• Feb. 3, 1913 16th amendment ratified
– 1st returns due 3-1-14
– rates from 2% to 6%
– 6% applied to >$500,000
• 1939 6% of U.S. population subject to tax
– Revenue Acts from 1913 to 1939 codified as IRC of 1939
History of U.S. Taxation (con’t)
• 1941 - 45 World War II
– by 1945 74% of U.S. population subject to tax (mass
tax)
– 1943 pay-as-you-go tax system
• 1950 - 63 top marginal tax rate 90 - 91%
– dropped to 70% and then 50% …
• 1988 - 90 top marginal tax rate 28%
• 1993 - 2000 top marginal tax rate 39.6%
• 2001 - 2004 top marginal tax rate drops from
39.1% to 35%
U.S. Constitution
16th Amendment
The Congress shall have the power to lay and collect
taxes on incomes, from whatever source derived,
without apportionment among several States, and
without regard to any census or enumeration.
Legislative Process
The Legislative Process
• influenced by economic, social, equity and political
considerations
• committee reports
– general structure
•
•
•
•
present law
reasons for change
explanation of provisions
effective date
– can provide Congressional intent
• especially for recently enacted provisions
– see example
The Legislative Process
• every bill passed has a public law number
– P.L. congressional session # - bill #
• congressional session # based on 2 year time periods
– 2007-08 is the 110th Congressional Session
– 2009-10 is the 111th Congressional Session
– P.L. 110-28 – Small Business and Work
Opportunity Tax Act of 2007
– P.L. 110-343 - The Emergency Economic
Stabilization Act of 2008
Internal Revenue Code
• Revenue Acts from 1913 to 1939 codified as
IRC of 1939
– followed by IRC of 1954 & IRC of 1986
• Title 26 of the United States Code
– LII: U.S. Code: Home
Internal Revenue Code (con’t)
• Subtitles (A – I + J & K)
– A, Income Taxes
• Chapters (1 – 98 + 99 & 100)
– some numbers are skipped
• 1-6, 11-14, 21-25, etc.
– continuous through all subtitles
• Subtitle A, Income Taxes – Chapters 1 – 6
• Chapter 1, Normal Taxes and Surcharges
• Subchapters (capital letters)
– not all chapters have
– start over at A for each chapter
– Subtitle A, Income Taxes, Chapter 1, Normal Taxes and
Surcharges, Subchapters A – X (no R)
– some subchapters associated with the subject covered
• C corporations in Subchapter C
• US CODE: Title 26,CHAPTER 1—NORMAL TAXES AND
SURTAXES
Internal Revenue Code (con’t)
• Parts (upper case Roman numeral)
– not all subchapters have
– start over at I for each subchapter
– some numbers are skipped
• Subparts (capital letters)
– not all parts have (fairly few)
• Sections (1 – 9602 + 9701 – 9833)
– continuous in Title 26 (not repeated)
– some numbers are skipped
– tax research generally focuses on code section
IRC Section
• subsection (lower case letters – a , b, c, etc.)
• paragraphs (numerical – 1, 2, 3, etc.)
• subparagraphs (upper case (capital) letters – A, B, C,
etc.)
• clauses (lower case Roman numerals – i, ii, iii, etc.)
• subclauses (upper case Roman numerals – I, II, III,
etc.)
• use parentheses for each division other than section
– Section 6662(d)(2)(C)(ii)(I)
• an exception
–
See Section 212
Reading the IRC
• complex sentence structures
– long sentences
– a number of clauses
– wordiness
• word usage
– some words are used in the IRC but would not
generally be used in other writing
• use of legalese
– Legalese
• SEC, “A Plain English Handbook, …” (ch. 2, pp. 30-35)
• an example - §183
Section 183
• activity is not engaged in for profit
– hobby
• gross income derived from such activity for
the taxable year exceeds the deductions
– profitable
– net income
• breeding, training, showing, or racing of
horses
– involves horses
10 common pitfalls in interpreting the code
1. Determine the limitations and exceptions
to a provision. Do not permit the language
of the Code Section to carry greater or
lesser weight than was intended.
2. Just because a Section fails to mention an
item does not necessarily mean that the
item is excluded.
3. Read definitional clauses carefully.
• Small Business Corp. - § 1244 versus § 1361
10 common pitfalls (con’t)
4. Do not overlook small words such as and
and or. There is a world of difference
between these two words.
•
see examples
5. Read the Code Section completely; do not
jump to conclusions.
•
special rules, exceptions, definitions, etc. are
often in another part of the section
10 common pitfalls (con’t)
6. Watch out for cross-referenced and related
provisions, since many Sections of the Code are
interrelated.
• See section 183
7. At times Congress is not careful when reconciling
new Code provisions with existing Sections.
Conflicts among sections, therefore, do arise.
8. Be alert for hidden definitions; terms in a
particular Code Section may be defined in the
same section or in a separate Section.
10 common pitfalls (con’t)
9. Some answers may not be found in the
Code; therefore, a researcher may have to
consult the Regulations and/or judicial
decisions.
10. Take careful note of measuring words
such as less than 50 percent, more than 50
percent, and at least 50 percent.
•
Journal of Business Strategy, 1972
Tax Treaties
• between the U.S. and other countries
– President enters into after receiving advice & consent of
the Senate
– > 60 countries
• may allow some income tax exemptions
• IRS Publication 901, U.S. Tax Treaties
– Income other than Personal Service Income
– Personal Service Income
• professors, teachers, and researchers
• students and apprentices
• wages and pensions paid by foreign government
Writing a Tax Memo
• see examples
• Structure for this Class (can be different)
– Facts
• summarize information provided
– briefly, succinctly
– Issue(s)
• state as a question
– Conclusion(s)
• one to two sentences (no authority cited)
– Reasoning
• discussion and analyze the authority that supports the
conclusion
• combine applicable law and analysis from the PAK example
Writing a Tax Memo (con’t)
• Cite code section in good form
– IRC § 265(a)(2)
– IRC Section 265(a)(2)
– IRC Sec. 265(a)(2)
• can eliminate IRC from any of the above citations
– Either include as part of the sentence
• “IRC § 989(a) has three requirements …”
– Or include a parenthetical reference at the end of the sentence
• The three requirements are … (IRC § 989(a))
• Writing tips
– do not use 1st person (“I” is not allowed)
• use 3rd person
– write formally
• no slang, clichés, or jargon
– keep direct quotes from IRC to a minimum
– no 1 sentence paragraphs (other than issue and conclusion statement)
– use spelling and grammar check
• also proofread by reading your writing aloud
– beware of autocorrect issues in Microsoft
Administrative & Judicial Sources
• PAK, Corp. Ch. 1, pp. 1-8 to 1-21
• Administrative Sources
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Regulations
Revenue Rulings
Revenue Procedures
Letter Rulings
Other IRS Pronouncements
• Judicial Sources
– Federal Court System
– Case Briefs
Vocabulary
• precedent (pres' e dent)
– noun
– law definition
• a legal decision or other authoritative material that
furnishes an example for deciding the treatment of
future similar or analogous situations
• precedential (pres' e den' shel)
– adjective
– of the nature of or constituting a precedent
The Department of the Treasury
• administers the tax laws of the United States
– Secretary of the Treasury is a member of the
President’s Cabinet
• Timothy Geithner
• Internal Revenue Service (IRS) is bureau
within Treasury
– See Treasury Organizational Chart
– headed by the Commissioner of Internal
Revenue
• Douglas Shulman
Regulations
• interpretation of the IRC
– Legislative Regulations
• Congress specifies in the IRC that Regulations will
provide details
– an example
• essentially the same authority as IRC
– highest precedential value of any IRS pronouncement
– General Regulations
• issued under general authority granted the IRS
– an example
Regulations (con’t)
• Proposed Regulations
– at least 30 days prior to final
• interest parties can comment on
• can be much longer process – example §162(m)
– bill passed 8/6/93
» rules effective 1/1/94
– regulations 1st proposed 12/20/93
– modifications proposed 12/2/94
– adopted 12/19/95
– “do not have the effect of law”
• Final Regulations
– issued after proposed regulations
Regulations (con’t)
• Temporary Regulations
– not subject to public comment
– effective immediately
– expire 3 years after issuance
• But if not replaced by final regulations continue to use
– provide immediate guidance
– considered the same authority as final regulations until
replaced by final regulations
• for example 1.469-5 versus 1.469-5T
• rare to challenge the authority of the Regulations
– “improper exercise of IRS power” or “overly broad
application of a rule”
Regulations (con’t)
• Citing Regulations
– type of regulation
• 1. for Income Tax
• 20. for estate, 25. for gift, 31. for employment & 301. for
procedural
– code section that regulation relates to
– number, paragraph, subparagraph
• number is consecutive within Reg. §
– starting with 0 or 1
– but does not necessarily related to subsections in code
– Reg. § 1.262-1(b)(2)
– add a T when temporary
Revenue Rulings
• 2nd to Regulations in authority of
administrative sources
• addresses a specific factual situation
– issue, facts, law and analysis & holding
– useful for fact situations that are similar
• cite
– Rev. Rul. year – number
• Internal Revenue Bulletin (IRB)
• Cumulative Bulletin (CB)
Revenue Procedures
• internal practices and procedures
– tend to be factual or procedural rules
• example – standard mileage rates for 2009
– Rev. Proc. 2008-72
• example – how to request a letter ruling and other
IRS guidance
– Rev. Proc. 2009-4
Letter Rulings
• Private Letter Rulings (PLRs)
– National Office of the IRS issues to a specific taxpayer
discussing a proposed transaction
• for a fee
– $275 - $11,500
– issue, facts, law and analysis & holding
• IRS’s interpretation
• open (proposed) transaction
– or tax return not yet filed
– is “substantial authority” under Reg. § 1.66624(d)(3)(iii)
• for penalty assessment
– for precedential value only provides authority for
taxpayer issued to
Letter Rulings (con’t)
• Technical Advice Memoranda (TAMs)
– completed transaction
– requested from National Office by agent during
audit
– applies to client being audited only
• Determination Letters
– issued by local district rather than National
office
– issues that are less controversial
– more likely to be a completed transaction
Letter Rulings (con’t)
• not published by the IRS
• but made publicly available
– added 1976
– identifying details eliminated
• published by tax services
• Ltr. Rul. 200430031
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–
–
–
year (4 digits) ( 2 digit before 2000)
week (2 digits)
number of ruling for week (3 digits)
includes PLRs, TAMs, and other IRS Pronouncements
• including Field Service Advice, Service Center Advice, …
Other IRS Pronouncements
• acquiescences and nonacquiescences
– response when IRS loses in court
– will follow or not follow the court
– example – IRS versus court for vacation home rental
• Bolton, 82-2 USTC ¶9699, 694 F2d 556 or McKinney, 83-2 USTC
¶9655
• Internal Revenue Bulletin (IRB)
– available on-line at IRS
– issued once a week
• Internal Revenue Bulletin
– combine into Cumulative Bulletin (CB)
• Chief Counsel Memoranda
– Technical Memorandum, General Counsel’s Memorandum, Action
on Decision
Overview of the Legal Process
• exhaust administrative review process
– within the IRS
• overpayment of tax versus deficiency
assessment
• 1st trial court then appeals
• historically burden of proof on taxpayer
– in 1998 shifted more to the IRS
Federal Judicial System
Tax Court
• hears only Federal tax cases
– technical tax issues
• 19 judges
• based in Washington
– trial court locations throughout the country
– usually one judge per trial
• no juries
• file petition within 90 days of IRS’s mailing
of notice and demand for payment
– disputed tax liability does not have to be paid
Tax Court (con’t)
• Decisions
– Regular
• new or unusual points of law
– Memorandum
• application of existing law
• interpretation of facts
– can be appealed to Court of Appeals
• if the circuits disagree on an issue the Tax Court should follow the
decisions in the circuit where the taxpayer is located
• Small Cases Division
– disputed deficiency not > $50,000
– informal
• legal representation not necessary
• no written briefs or formal oral arguments
– cannot be used as precedent
– decision final and cannot be appealed
District Courts
• hears all legal issues based on the U.S. Code
• disputed tax liability must be paid
• country divided into districts
– file in district where taxpayer lives
– See Circuit Court Map
• case heard by one judge
– jury possible
• questions of fact only
• can be appealed to Court of Appeals
Court of Federal Claims
• cases concerning monetary claims
– disputed tax liability must be paid
• 16 judges
• based in Washington
– trial court locations throughout the country
– no juries
• not required to follow circuit Court of Appeals
decisions
• can be appealed to Court of Appeals for the
Federal Circuit
Court of Appeals
• usually question of law not fact
• 13 circuits
– 11 geographic
– Washington, D.C.
– Court of Appeals for the Federal Circuit
• each circuit independent and only has to
follow Supreme Court decisions
• typically three-judge panel
– no juries
Supreme Court
• highest court in U.S.
– hears very few tax cases
– usually if conflict among Federal circuits or issue of major
importance
• 9 judges hear every case
• located in Washington, D.C.
• file a writ of certiorari to request case to be heard
– certiorari is granted
– certiorari is denied
• If Congress disagrees then pass new laws or clarify existing
laws
– Soliman, 113 SCt 701, 93-1 USTC ¶50,014 – home office deduction
under § 280A
– 1997 Taxpayer Relief Act (PL 105-34) modified § 280A
Cites for Cases
• Tax Court
– Regular
• Hillman, D. H., 114 TC 511(2000) (permanent) or
• Hillman, D. H., 114 TC __, No. 32 (2000)
(temporary)
– Memorandum
• Nicholls, Walter J., 69 TCM 3042 (1995) (CCH) or
• Nicholls, Walter J., T.C. Memo 1995-291 (general)
– Small Cases Division
• Fields, Edward M., TC Summary Opinion 2001-35
Cites for Cases (con’t)
• District Court
– Barber, Lori, 2000-1 USTC ¶ 50,209 (N.D.C.A.,
2000) (CCH) or
– Barber, Lori, 85 AFTR 2d 2000-879 (RIA) or
– Barber, Lori, 85 F.Supp.2d 967 (N.D.C.A., 2000)
(West)
• Court of Federal Claims
– Bennett, Courtney, 94-1 USTC ¶ 50,044 (Fed.
Cl., 1994) (CCH) or
– Bennett, Courtney, 73 AFTR 2d 94-1042 (RIA)
or
– Bennett, Courtney, 30 Fed. Cl. 396 (1994) (West)
Cites for Cases (con’t)
• Court of Appeals
– Oxford Capital Corp., 2000-1 USTC ¶ 50,447 (CA-5,
2000) (CCH) or
– Oxford Capital Corp., 85 AFTR 2d 2000-1840 (RIA)
or
– Oxford Capital Corp., 211 F.3d 280 (CA-5, 2000)
(West)
• F.2d for older cases
• Supreme Court
– Indianapolis Power and Light, 90-1 USTC ¶ 50,007
(USSC, 1990) (CCH) or
– Indianapolis Power and Light, 65 AFTR 2d 90-394
(RIA) or
– Indianapolis Power and Light, 110 S.Ct. 589 (1990)
(West)
Case Briefs
• summarize case briefly (1 -2 pages)
–
–
–
–
–
citation
issue(s)
facts
holding
reasoning
• http://www2.gsu.edu/%7Eaccerl/
Evaluating Law and Rules & Ethics
• Evaluating Sources of Law
• Citators
– CCH & Shepard’s for Supreme Court within
LexisNexis Academic Universe
• Rules and Ethics in Tax Practice
– Circular 230 (on Blackboard)
– AICPA Code of Professional Conduct
– Statements on Standards for Tax Services (on
Blackboard)
– NC Professional Ethics and Conduct
• North Carolina Accountancy Rules found in Subchapter 8N –
Professional Ethics and Conduct (summary on Blackboard)
Evaluating Sources of Law
• administrative sources
– Regulations are generally held to be valid by
the Courts
– Revenue Rulings and Revenue Procedures
might be modified or held invalid by the courts
Evaluating Sources of Law (con’t)
• Court Cases
– a case should summarize the evolution of the
tax law prior to the case
• starting with a recent case might give cites to earlier
relevant cases
– decisions by higher courts carry more weight
– District Court & Circuit Court of Appeals
opinions in the taxpayer’s circuit carry more
weight than ones not
Evaluating Sources of Law (con’t)
• Court Cases (con’t)
– Tax Court and Court of Claims decisions are
binding on all jurisdictions, unless overturned on
appeal
– circuits are assigned more weight
• 2nd (NY, CT & VT)
• 9th (CA, WA, OR, NV, AZ, ID, MT)
• federal (Court of Federal Claims)
– older cases should be given less weight
• § 183 added for tax years after 12/31/69
• Reg. § 1.183-2 adopted 7/12/72
– Action on Decision (AOD)
• example
Citators
• how up to date is your research?
• annotations
– other cases referred to within a court case
• cited, followed, criticized, questioned, explained
– case appealed
• affirmed, reversed, modified, overruled, remanded,
vacated
– administrative sources
• superceded, modified, revoked, withdrawn
Citators (con’t)
• citing case
– case that makes reference to another case
• cited case
– case that is referenced by another case
• citator
– provides information on citations to cases
– may or may not tell you how the cases are related
• example Soliman, 113 Sct 701, 93-1 USTC ¶ 50,014
• CCH & RIA
– CCH - just a list of cases
– RIA – annotation for each case
– also can link to annotation
• Shepard’s for Supreme Court within Lexis/Nexis Academic
– indicates annotation for each case
– “shepardizing the case”
» (Legal tab then Shepard’s Citations)
Circular 230
• practice before the IRS
– consists primarily with representing the client
during an audit
• who may practice
– attorneys
– certified public accountants
– enrolled agents
• pass an IRS exam or worked for the IRS for 5 years
– enrolled actuaries
Circular 230 (con’t)
• limited practice without enrollment
–
–
–
–
family members
employee for employer
partner for a partnership, officer for a corporation
trustee, receiver, guardian, personal representative,
administrator or executor
• tax return preparers
– signs a return as preparer
– “limited practice”
– only before the Examination Division of the IRS
Circular 230 (con’t)
• conduct before the IRS
– furnish information requested by the agent
• unless request is questionable
– unrelated to tax return?
– confidential
– do not delay matters unreasonably
Circular 230 (con’t)
• due diligence
– honest with clients
– simple errors happen
• but at some point an error goes beyond what a reasonable person
would expect from a tax preparer
• contingent & unconscionable fees
– contingent fee not allowed on original return
– allowed for amended or claim for refund
– unconscionable fee if too high for complexity of return
• solicitation & advertising
– must not contain false, fraudulent, unduly influencing, coercive, or
unfair statements or claims
• tax return positions
– IRC § 6662 – substantial authority
– realistic possibility now reasonable belief (2007 change)
• 1 in 3 likelihood now 1 in 2 likelihood
AICPA Code of Professional Conduct
• details are covered in Advanced Auditing
– not responsible for here
• related to tax matters
– more restrictive than Circular 230
• contingent fee not allowed for original return,
amended return, or claim for refund
• advertising & solicitation
– “creates a false or unjustified expectations of favorable
results”
– Ryan & Company, America's State & Local Tax Advisors
» an example of a firm that is “not a CPA firm”
Statements on Standards for Tax Services
• issued by the AICPA
– enforceable standards for AICPA members
• tax return positions
– similar to IRS – realistic possibility and substantial authority
• answers to questions on returns
– make reasonable effort to obtain answers
• certain procedural aspects of preparing returns
– can rely on client provided information
• unless appears incorrect, incomplete or inconsistent
• don’t have to review supporting documentation
• use of estimates
– supplied by taxpayer
– appears reasonable
– certain expenses have more restrictive substantiation requirements
• for example, travel & entertainment
Statements on Standards for Tax Services
(con’t)
• departure from previous position
– allowed unless bound by the IRS as part of audit
resolution
• knowledge of error
– return preparation
• if significantly effects tax liability
– notify client but not the IRS of errors on prior returns
– ensure error is not repeated in current return
– administrative proceedings
• request client’s permission to disclose to IRS
– withdraw from engagement if client does not agree?
• form and content of advice to taxpayers
– professional competence
North Carolina
• North Carolina State Board of Certified Public
Accountant Examiners
– NC State Board of Certified Public Accountant Examiners
– Professional Ethics & Conduct
• See NC Accountancy Rules Ethics & Conduct
• all CPAs
• CPAs using CPA title in offering or rendering products or
services
• CPAs performing attest services
• overlaps substantially with AICPA
• some examples (available on the website)
– Roger William Younts
– Tracie Wright Cox
Working with the IRS
Tax Practice & Administration
• Working with the IRS
– Organization of the IRS
– Taxpayer Rights
– The Audit Selection Process
– Examinations
– The Appeals Process
• Tax Practice & Administration
– Taxpayer Penalties
– Penalties on Return Preparers
– Interest
– Statutes of Limitations
• PAK, Corporations Chapter 15, Administrative
Procedures
IRS Facts & Figures
• almost 134 million individual returns (2006)
– 60.2% efile (TY 2006)
– 59.6% paid preparers (TY 2005)
– 102 million refunds (TY 2005)
• business returns
– over 2.4 million C corporation returns (2006)
– over 3.5 million S corporation returns (2004)
– over 2.7 million Partnership returns (2005)
• over 31 million employment tax returns (2006)
• over 1.2 million other (gift, estate & excise) (2006)
IRS Facts & Figures
• 99,000 employees (FY 2004)
• budget
– 10.811 billion FY 2006 (actual)
– 10.960 billion FY 2007 (proposed)
• collect almost 2 trillion (net – after refund) (2005)
– 880 billion from individual income tax (44.0%)
– 273 billion from corporate income tax (13.7%)
– 766 billion from employment taxes (38.3%)
• 755 billion social security & medicare
– 25 billion from estate and gift (1.2%)
– 55 billion from excise taxes (2.8%)
IRS National Office
• Commissioner
– Deputy Commissioner for Services & Enforcement
• Operating Divisions
– wage and investment
» approximately 116 million taxpayers
– small business and self employed
» approximately 45 million small businesses & self-employed
– large and mid-size businesses
» corporations with assets >$10 million
– tax-exempt & government entities
• Criminal Investigation
• Office of Professional Responsibility
– National Taxpayer Advocate
– Appeals
– Deputy Commissioner for Operations Support
• agency wide shared services
Organization of the IRS
• National Office in DC
• IRS Service Centers
– 8 service centers serve IRS regions
– process & mathematical verification of returns
• where you mail your tax return
•
•
•
•
IRS Data Center – Detroit
National Computer Center – Martinsburg, WV
other Computing centers & Processing Centers
Customer Service Centers
– telephone & electronic contact
Taxpayer Advocate
• National & Local
• taxpayer-intervention system
– taxpayer representative with the IRS
• Taxpayer Assistance Order (TAO)
– to suspend, delay, or stop actions
• taxpayer is suffering or about to suffer a significant
hardship due to IRS’s administrative handling of
situation
• might involve levy of property or collection activities
Taxpayer Advocate (con’t)
• report annually to Congress
– 2009 issued
– Most Serious Problems
• at least 20 required
• 21 in 2009
– Legislative Recommendations
• 11 in 2009
– Most Litigated Issues
• top 10 litigated
Taxpayer Rights
• Taxpayer Bill of Rights
– evolved from 1988 to 1998
– current version was part of the IRS Restructuring and Reform Act
of 1998
– in response to abusive behavior by IRS agents
• Taxpayers are guaranteed
– rights to representation before the IRS
• attorney, CPA, or other authorized representative
– recordings of proceedings
– an IRS explanation of its position relative to a pertinent
disagreement
– why is IRS requesting information, how will they use it & what
might happen if requested information withheld
– must separately notify both spouses of tax deficiencies, audits,
appeals, etc.
Tax Gap
• based on tax year 2001
• $1,767 billion paid voluntarily and timely
– voluntary compliance rate of 83.7%
• estimated at 345 billion
– 16.3% noncompliance rate
• difference between what should be paid and what
is actually paid
– underreporting – $285 billion (82.6%)
– nonfiling - $27 billion (7.8%)
– underpayment $33.5 billion (9.7%)
Audit Selection Process
• system of voluntary compliance
– but do collect substantial revenue through withholding
• almost 85% of the returns have some amount of wages (2004)
–
–
–
–
$4,921,806,344,000 income from salaries & wages
$ 394,285,849,000 income from taxable pensions & annuities
$ 315,993,163,000 income from partnerships & S corps.
$ 247,217,288,000 income from trade or business
• threat of audit increases compliance
• audit rate fairly low
– audit rate for all returns was 1.0% for returns filed in
2006
• 6.2% of individuals with Schedule C with gross receipts from
$100,000 to $200,000
• 16.8% of large corporations with ≥10 million in assets
• 19.9% of estate returns with ≥$5 million in value
– but use statistical models and computer technology to
maximum audit effectiveness
Audit Selection Process (con’t)
• Preliminary Review
– simple and obvious errors
– IRS Automatic Data Processing (ADP)
Program
• computer matching W-2s, 1099s, etc.
• mathematical / clerical error program
– send taxpayer a corrected tax computation and request
payment (or adjust refund)
• unallowable items program
– corrections at this stage are not an examination
(not an audit)
• no administrative or judicial appeals process
Audit Selection Process (con’t)
• Selection of Returns for Examination
– Discriminant Function Program
• discriminant function formula (DIF)
– assigns numeric weight to return items
– each return assigned a mathematical score
» higher DIF score => higher probability of audit
– Taxpayer Compliance Measurement Program
• investigating type & number of errors in
representative sample of returns
– TCMP audits are very detailed
– 1995 – stopped due to budget constraints
• used to develop DIF formula
Audit Selection Process (con’t)
• Selection of Returns for Examination
– National Research Program (NRP)
• snapshot of compliance
• from 2002 to 2004
– approximately 50,000 returns annually reviewed and
examined
– but use existing audit data
• IRS uses NRP data to update DIF formula
Audit Selection Process (con’t)
• Selection of Returns for Examination (con’t)
– Other Selection Methods
• information from informants
– 1-800-829-0433
• linked to another return being audited
– partners & partnerships
– shareholder & closely-held corporations
• level of income or gross receipts
– higher => greater probability of audit
• filed an amended return
• economic reality audit
– relationship of income and deductions
– variance in self-employment income
– significant increases or decreases in items
Audit Selection Process (con’t)
• Selection of Returns for Examination (con’t)
– Chances of Audit
•
•
•
•
•
•
tax shelter losses
home office deduction
cash-oriented business
business losses
prior audit adjustments
itemized deductions too high in relation to income
% Using Itemized Deductions (2002)
If itemizing % (avg. $) deducting:
% (avg.$ per)
itemizing
medical
taxes
all
35.0%
$19,293
18.7%
$6,083
98.2%
$6,674
82.3%
$9,150
88.7%
$3,372
<15
4.9%
$12,771
63.7%
$7,400
90.6%
$2,237
60.0%
$7,043
72.8%
$1,423
15-30
16.9%
$12,239
45.3%
$5,890
94.9%
$2,327
68.8%
$6,453
80.7%
$1,890
30-50
39.6%
$13,096
25.1%
$4,994
98.1%
$3,187
80.1%
$6,850
84.2%
$2,006
50-100
70.9%
$16,777
11.7%
$5,672
99.1%
$5,173
86.9%
$8,364
91.1%
$2,530
100-199
91.5%
$25,768
4.5%
$10,969
99.6%
$9,785
87.5%
$11,825
95.5%
$3,875
≥200
93.8%
$65,923
1.5%
$28,305
99.7%
$35,815
84.1%
$21,998
96.7%
$17,354
AGI (000s)
interest charitable
Examinations (audit)
• Correspondence (≈ 71%)
– by mail or telephone
– one or two items questioned
• often requiring support for one or more itemized
deductions
– medical, taxes, interest, charitable, miscellaneous
– verify income, deduction or credit item
• provide receipts, cancelled checks, etc.
– if more complicated then thought to be then
might be moved to office or field audit
– allowed administrative & judicial appeal
Examinations (con’t)
• Office (≈ 9%)
– conducted at an IRS district office
– questioning one or more items
• listed in audit notification letter
• bring support for questioned items
– might come to you if support is difficult to bring in
– usually only used for individual income tax returns
without business income including:
•
•
•
•
dependency exemption
income from tips, rents & royalties
deductions for travel & entertainment
casualty and theft losses
Examinations (con’t)
• Field (≈ 21%)
– issues more complex
• usually business returns
– corporations
– individuals with more substantial Schedule C income
– complete review of return
• also overall business
– usually at taxpayer’s offices
• could be at taxpayer’s representative
• might use a team of auditors
– Coordinated Examination Program
• large corporations
• http://www.irs.gov/pub/irs-utl/planning__monitoring_tool.pdf
Examinations (con’t)
• Dealing with an Auditor
– review the strengths & weakness of the return before
working with the auditors
– courteous, professional, cooperative, & responsive
– provide adequate work accommodations
• don’t allow too much access to offices & employees
• don’t volunteer information
• don’t allow auditor to browse through information not
requested
– communications should be in writing
– resolution
• some issues might be resolved in the field
• remaining issues carryover to next phase
Examinations (con’t)
• Conclusion of Examination
– proposed adjustments
• Revenue Agent’s Report (RAR)
– can agree to adjustments and sign off at this time
– if don’t agree
• probably meet with group supervisor or appeals agent to attempt
resolution
• Thirty-Day Letter
–
–
–
–
received if proposed adjustments not resolved
formal notification of proposed adjustments
informs about rights to appeal
30 days to request a conference with a appeals officer
• orally if proposed tax adjustment & penalties ≤$2,500
• written if >$2,500
• a formal protest if >$10,000
– facts, issues, authority
– if taxpayer does not respond within 30 days then 90 day letter
Examinations (con’t)
• File a Protest or Go Straight to Court?
– Advantages to Protest/Appeals Process
• possibly settle without costly litigation
– can still litigate
• further delay for paying tax liability
• more insight into government’s position & more time to
develop support for taxpayer’s position
• might be able to later recover some costs later
– government’s case is largely unjustified
– all administrative remedies were pursued
– Advantages to Bypassing Appeals
• government cannot raise new issues
• taxpayer appears confident of position
• faster conclusion
The Appeals Process
• Appeals Conference
– informal proceeding
– appeals officer allowed to use judgment
• negotiated settlement
– might “split or trade issues”
• can refuse to settle on certain issues
• Ninety-Day Letter
– statutory notice of deficiency
– 90 days to file a petition with the U.S. Tax Court
– after 90 days can only contest if tax assessment paid
• file claim for refund
• claim denied by IRS
• file refund suit in district court or Court of Claims
– might have one more meeting with appeals officer and IRS
attorney
• in court IRS is more likely to succeed than taxpayer
Timeline
audit
revenue
agent’s
report (RAR)
proposed
adjustments
discussed
30 day letter
appeals
conference
90 day letter
Taxpayer Penalties
• Civil versus Criminal
– civil
• monetary fine
• evidence
– “preponderance of the evidence” (>50% certainty)
– “clear & convincing” (tax & some other tort claims)
– criminal
• criminal process
– same process for nontax criminal defendants
» no unreasonable search & seizures, no double jeopardy, right
to a speedy trial, right to the assistance of counsel, etc.
– constitutional guarantees
– evidence – “beyond a shadow of any reasonable doubt” (98-99%
certainty)
• usually includes prison
– can be liable under both
Taxpayer Penalties - Civil
• ad valorem penalties
– based on % of the delinquent tax
• assessable penalties
– flat $ amount
• imposed when violation is
– without reasonable cause
– the result of negligence or intentional disregard
– through a willful disobedience or outright fraud
Taxpayer Penalties – Civil (con’t)
• reasonable cause (some examples)
–
–
–
–
–
–
–
reliance on advice of competent tax professional
mailed with insufficient postage or to wrong address
death or serious illness of taxpayer or immediate family
destruction of business, residence or records by casualty
IRS did not provide necessary assistance or information
unavoidable absence by the taxpayer
unavoidable inability to obtain necessary tax records
• not reasonable cause (some examples)
–
–
–
–
lack money to pay
ill or injured but not incapacitated
taxpayer in jail
taxpayer alleges ignorance
Taxpayer Penalties – Civil (con’t)
• failure to file a tax return
– due to willful neglect
• assumed unless reasonable cause shown
– 5% of the tax for each month
• using calendar months & any fraction of a month is
a full month
• maximum 25%
• if within 60 days, minimum is lesser of $100 or tax
due
– if fraudulent failure then 15% / month for a
maximum of 75%
Taxpayer Penalties – Civil (con’t)
• failure to pay tax
– unless reasonable cause shown
• assumed if granted an automatic filing extension when tax due
< 10% of total tax
– See Form 4868
– tax shown on filed return
– an assessed deficiency
• if not paid within 10 days of notice
• or not paid within 21 days when tax due < $100,000
– 0.5% of the tax for each month
• using calendar months & any fraction of a month is a full
month
• maximum 25%
• reduce failure to file by failure to pay when both apply
Taxpayer Penalties – Civil (con’t)
• failure to pay tax
– a simple example
• Samantha files her income tax return 65 days after
the due date of the return without obtaining an
extension from the IRS. Along with the return, she
remits a check for $10,000, which is the balance of
the tax she owes. Disregarding the interest element,
what are Samantha’s total penalties for failure to file
and failure to pay?
Taxpayer Penalties – Civil (con’t)
• accuracy-related penalty
– 20% of the tax deficiency related to:
• negligence or disregard of applicable tax law
– “negligence” – failure to make reasonable attempt to comply
– “disregard” – careless, reckless, or intentional disregard
•
•
•
•
•
substantial understatement of tax
substantial valuation overstatement
substantial overstatement of pension liabilities
substantial understatement of estate & gift tax valuation
“substantial” definition varies by category
– example
» noncash charitable (valuation) - 200% or more of actual
value
» income tax – 10% or $5,000 ($10,000 for a C corporation)
– have not shown reasonable cause or good-faith effort to
comply
• “substantial authority” under §6662
Taxpayer Penalties – Civil (con’t)
• civil fraud
– portion of underpayment is attributable to
fraud
– penalty is 75% of the underpayment that is
attributable to fraud
• but most other penalties will not be applied
simultaneously
– fraud not specifically defined in code & regs
• judicial decisions have developed definition
– actual, intentional wrongdoing
– done without “bad or evil purpose”
– willfulness – a voluntary, intentional violation of a know
legal duty
Taxpayer Penalties – Civil
(con’t)
• “Fraudulent intent is rarely established by direct evidence.
As a consequence, courts have inferred fraudulent intent
from various kinds of circumstantial evidence.” (Unger, TC
Memo 2000-267, 80 TCM 276)
• examples
–
–
–
–
–
–
–
–
–
–
–
–
two sets of books
false accounting entries
destroying books or records
dealing in cash
concealing assets or sources of income
consistently understating income or overstating deductions
purposely avoiding preparing business records
failure to file tax returns
implausible or inconsistent explanations of behavior
failure to cooperate with tax authorities
engaging in illegal activities
attempting to conceal illegal activities
Taxpayer Penalties – Civil (con’t)
• civil fraud (con’t)
– Unger, TC Memo 2000-267, 80 TCM 276
• issues are:
– (1) Whether petitioner had unreported taxable income
during the years at issue, and
– (2) whether petitioner is liable for additions to tax for fraud
(section 6653(b)) and fraudulent failure to file (section
6651(f)).
• illustrates use of the net worth method
– allowed under § 446(b)
– burden of proof on taxpayer to prove that it is “arbitrary
and excessive”
Taxpayer Penalties - Criminal
• criminal legal process
– punishment can include prison time
– IRS held to a greater burden of proof
• usually reserved for more flagrant offenses
– willful conduct
• “a voluntary, intentional violation of a known legal duty”
(Valenti, 121 F3rd 327)
– law imposes a duty, taxpayer knows of the duty, and voluntarily
and intentionally violated that duty
» details of offenses, penalties & imprisonment potential not
required
– Valenti, 97-2 USTC ¶50,629, 121 F3d 327
Penalties on Return Preparers
• income tax return preparer (ITRP)
– prepares for compensation
• all or a substantial portion of a tax return or
– not substantial if
» the portion prepared involves an amount < $2,000 or
» <$100,000 and also <20% of the gross income (or AGI for
individual)
• claim for refund
– self-employed, employer or employee
• penalties might be different
• return preparation
– can include tax advisors, planners, software designers,
and consultants
• even if only reviewing or instructing
Preparer Disclosure Penalties
• give taxpayer a complete copy of the return
when presented for signature
• sign return as preparer
• provide preparer’s ID # on return
• retain copies of all returns prepared
– or list of taxpayers and their ID numbers for 3
years
• retain list of all preparers who have worked
in the past 12 months
• maximum penalty of $25,000 per calendar
year
Preparer Conduct Penalties
• civil & criminal
– endorsing or negotiating a refund check (civil)
– understatements due to unrealistic positions (civil)
• realistic possibility requires a 1 in 3 likelihood that the position
will be upheld
– willful understatement (civil)
• willful, reckless or intentional disregard
– aiding and abetting understatement (civil)
• aiding & assisting in preparation of false return (criminal fraud)
– disclosure or use of information by return preparers
(civil & criminal – knowingly & recklessly)
– tax shelters promoters (civil)
Interest
• on underpayments & overpayments
– for underpayment interest calculated from last
date to pay tax (i.e. unextended due date) to
date actually paid
• compounded daily
– for overpayment
• IRS has 45 days from unextended due date or filing
date of return (whichever is later) before interest
required to be paid
• IRS does not have authority to forgive
payment of interest
• interest is charged on some penalties
Interest
• rate updated quarterly
– noncorporate overpayments and underpayments
• short-term rate + 3%
• as of Jan 1, 2010 (same since April 1, 2009) rate is:
– short-term rate = 1%
– 4% for noncorporate over and under
• use same rate for underpayments & overpayments for noncorporate
as of January 1, 1999
– corporate overpayments
• short-term rate + 2%
• as of Jan. 1, 2010 rate is 3%
• corporate overpayments >$10,000 receive short-term rate + 0.5%
(1.5%)
– corporate underpayments
• short term rate + 3%
• as of Jan. 1, 2010 rate is 4%
• large corporations underpayments are 2% higher (6% for Jan. 1)
– rates and rules for application of rates have changed over the years
Statutes of Limitations
• time period to assess tax, file for refund, or select
for audit
– generally 3 years from unextended due date or filing
date (whichever is later) for assessment or audit
selection
• 6 years if income omitted is >25% of gross income reported
• not filed then time period never expires
– generally 2 years from when tax paid for refund
• IRS will request an extension to complete audit or
appeals process
– taxpayer does not have to agree to
– but not agreeing could lead IRS assessing a deficiency
prematurely
Tax Planning
• Tax Planning
– Economics of Tax Planning, Avoidance, and
Evasion
– Tax Rate Terminology
– Tax Planning
Economics of Tax Planning
• Tax planning helps a client look to the future
– goals & how to get there
– can allow for creativity
• but avoid tax evasion and abusive tax avoidance
– make appropriate comparisons
• 2 or more alternatives in the current time period
versus
• an alternative today compared to an alternative in
the future versus
• 2 or more alternatives starting today and projecting
into the future
Economics of Tax Planning
• taxes are an additional cost of doing
business or of wealth accumulation
– from an economics perspective wealth
maximization is our primary goal
• reduce the net present value of the tax liability
– Time Value of Money
» tables, calculator or Excel
» inputs (N, I, PV, FV, PMT)
» examples
» what interest rate? http://www.bankrate.com
– but also have to consider goals other than tax
minimization
Economics of Tax Planning (con’t)
• trade off costs and benefits
– don’t want costs > benefits
• income taxes paid do not reduce future taxable
income (not a deduction)
• before tax and after tax cost
–
–
–
–
ATC = after-tax cost
BTC = before-tax cost
MTR = marginal tax rate
ATC = BTC (1 – MTR)
• an example
Tax Rate Terminology
• tax base X tax rate = tax liability
• tax base
– amount to which tax rate is applied
– what to include or exclude?
– base broadening – more included
• types of tax rate structures
– proportional
• same rate applies to all levels of tax base
– progressive
• tax rate increases as the tax base grows larger
– regressive
• tax rate decreases as the tax base grows larger
Tax Rate Terminology (con’t)
• distribution of taxes in an economic analysis
– proportional
• the fraction (or %) of income paid in taxes is the same for all levels of
income
– progressive
• the fraction (or %) of income paid in taxes increases in income
– regressive
• the fraction (or %) of income paid in taxes decreases in income
• tax incidence is the study of tax burdens
– who bears the weight of a tax?
• T = burden of tax on individual
• I = income of individual
• T / I = effective tax rate
– when higher for rich than poor then progressive
– when higher for poor than rich then regressive
• “For instance, a cigarette tax is usually viewed as regressive, since the
fraction of a poor individual’s income that is spent on tobacco is
higher than the fraction spent by a rich individual.” (Stiglitz,
Economics of the Public Sector, 1988)
Tax Rate Terminology (con’t)
• marginal tax rate
– tax rate on next dollar of taxable income
• average tax rate
– tax / tax base
• nominal
– use income after exemptions, exclusions, and deductions
(taxable income for individual income tax)
• effective
– use income before exemptions, exclusions, and deductions
(gross income for individual income tax)
Tax Planning
EDUCATION
ESTATE
trusts for minors
special investments
asset management
distributions & control
RETIREMENT
INCOME TAX
INVESTMENT
qualified plans
nonqualified plans
distributions
plans & vehicles
timing
tax entity
exclusions & deductions
income classification
special taxes
withholding
interest & penalties
risks & rewards
control
purchases / sales
asset allocation
regulations
CASH
RISK
budgeting
finance
insurance
security
Tax Planning (con’t)
• Avoiding Income Recognition
– seek economic income that is not recognized for
tax purposes
• municipal bonds (state & local obligations)
• invest in assets that appreciate in value rather than
generate income
• borrow against appreciated assets rather than sell
the asset and pay tax on the gain
– but will be paying interest on the debt
• receive nontaxable fringe benefits rather than
taxable compensation
Tax Planning (con’t)
• Postponing Income Recognition
– present value of $1 paid next year is lower than present
value of $1 paid this year
– delaying income, delays taxes, & allows investing taxes
saved in alternatives
– time the selling assets
• Changing Tax Jurisdictions
– changing location of taxable activities to lower taxes
• state, local, & foreign location decision
• individual deciding where to live
• business deciding where to locate
Tax Planning (con’t)
• Controlling Classification of Income
– ordinary, investment, & passive
• capital gains taxed at lower rates
– but capital loss might not be deductible when generated
• dividends now taxed at lower rate
• passive loss might not be deductible when incurred
• Spreading Income Among Related Taxpayers
– family members
– closely-held business entities
– must transfer the assets generating the income
• cannot assign your income to another person or entity
Retirement Planning
• in your 20s
–
–
–
–
decrease spending & increase savings
put savings on autopilot
live beneath your means
start saving for retirement
• in your 30s
–
–
–
–
concentrate on your career
have a family (if you plan to)
set goals
save as much as possible
Retirement Planning
• in your 40s
–
–
–
–
–
continue to save
monitor your investments
refine your retirement plan
invest in a rental / vacation home
start organize what you will do in retirement
• in your 50s
–
–
–
–
–
review your real estate
stay with stocks for retirement assets
do a benefits check
stop supporting grown children
devise a tax strategy
• based on Business Week, Annual Retirement Guide, July 9 &16, 2007
Financial Research (8th Power Point)
• Introduction to Financial Research
• Authoritative Financial Literature
– FASB
• “Facts About FASB”
– pdf file posted on Blackboard
– AICPA
– SEC
– GASB (not covered)
Research Steps
1.
2.
3.
4.
5.
Identify the relevant
facts and issues
Locate authority and
collect the evidence
Analyze the results
and identify the
alternatives
Develop conclusions
and recommendations
Communicate the
results and
recommendations
1.
2.
3.
4.
5.
6.
Determine the facts
Identify the issues
Locate applicable
authority
Evaluate authorities
Analyze the facts in
terms of applicable
authority
Communicate
conclusions and
recommendations
From The Uniform CPA Examination Alert Spring 2009
What is your focus in seeking new ways to assess research skills?
We are now developing research tasks that involve not only searching
authoritative literature, but also making use of the findings. At the time
CBT was launched in 2004, not all students were being instructed in
research skills as part of their curricula. This has now changed. Research
courses are available at many institutions. In our national survey of entrylevel practice last year, we recognized that the time has come to expand the
testing of research skills. We are also using content experts to guide us in
identifying the ways in which entry-level practitioners are finding and
using information. This is leading us to explore research topics outside the
scope of authoritative literature. We plan to field-test this type of research
task with students in accounting programs. If successfully tested, we could
introduce research tasks that rely on alternative databases, exhibits and
resources. Our consideration of other sources reflects the recognition that
CPAs must often rely on a variety of information and data sources. Some
of the resources we have been exploring include Thomas, the Library of
Congress record of legislation, the U.S. Tax Court database of tax court
rulings, and information databases, such as financial reports submitted to
the SEC in XBRL format. No decisions have as yet been made concerning
these resources but their use is being explored.
• http://www.cpa-exam.org/
CPA Exam Changes
• effective January 1, 2011
• for Financial Accounting and Reporting (FAR)
– IFRS
• “identify and understand the differences” between U.S.
GAAP and IFRs
– “research relevant professional literature”
• FASB Accounting Standards Codification
• will continue to use current financial research database
through end of 2010
• “The exam may not use the most current version of
Literature. You are to use the version provided to
answer the research question.”
General Accepted Accounting Principles
(GAAP)
• American Institute of Certified Public Accounting
(AICPA)
– the Committee on Accounting Procedure (CAP)
• 1936 – 1959
• issued Accounting Research Bulletins (ARB)
– the Accounting Principles Board (APB)
• 1959 – 1973
• issued Opinions (APB) and Statements (APS)
– Pronouncements of these two predecessors remain in
force unless amended or superceded by the FASB
GAAP (con’t)
• Financial Accounting Standards Board
(FASB)
– 1973 – present
– private sector organization for establishing
financial accounting and reporting standards
– recognized as authoritative by SEC and AICPA
– Statements of Financial Accounting Standards
(SFAS or FAS)
• also Statements of Financial Accounting Concepts
(SFAC or CON), Interpretations (FIN), Technical
Bulletins (FTB), Implementation Guides (Q&A),
FASB Staff Positions (FSP), etc.
– now the codification
The Organization
• Financial Accounting Standards Board (FASB)
– 5 members as of July 1, 2008
• sever prior connections (firms, universities, etc.)
• previously 7 members
– appointed for 5 year term (allowed 2 terms)
• terms staggered (1 term expires every year)
• Financial Accounting Standards Advisory Council
(FASAC)
– consults with FASB on technical issue, project
priorities, etc.
• more than 30 members
• annually conduct a survey concerning the priorities of the
FASB
The Organization (con’t)
• Financial Accounting Foundation (FAF)
– 14-18 trustees (changed to flexible size in 2008)
• from 8 constituent organizations and
• at-large
– selects members of the FASB and its advisory council
– responsible for the oversight, administration and finances of the
FASB and FASAC
• FASB funding now comes from accounting support fees
– authorized by the Sarbanes-Oxley Act of 2002
• See FASB Audited Financial Statements
• See FAF annual report
– also established
• Emerging Issues Task Force (EITF)
– formed 1984
– issue Consensus Positions
• Governmental Accounting Standards Board (GASB)
– established 1984
• FASB's codification and retrieval database project
– approved Sept. 2004
– verification phase began January 15, 2008
– became a single source of authority on July 1, 2009
FASB’s Standard Setting
• “open, orderly process for standard setting”
• identify topics for technical agenda
–
–
–
–
input from constituencies
FASAC survey
EITF
technical inquiries on issue
• open decision-making meetings
– observers do not participate
– also broadcast on FASB website
• public exposure drafts for FASB statements and
interpretations
– comments within the exposure period
• minimum of 30 days (can be longer)
Statements of Financial Accounting
Standards (FASs)
• statements generally include:
–
–
–
–
–
–
–
–
introduction (or objective)
background information
basis for conclusion
opinion or standard
effective date (and transition if necessary)
illustrations of applications
disclosure required
amendments to existing pronouncements
• cite paragraph number(s) when referring to statements
• FAS 157 as an example
EITF
• timely financial reporting guidance
– within the framework of existing authoritative
literature
• membership drawn from constituencies
– currently 15 members
– also chief accountant of the SEC can attend and speak
but not vote
• consensus opinion indicates to the FASB that no
further action is required
– no more than 3 voting members attending the meeting
object
– ratified by FASB
• meetings are public and comments are requested
EITF (con’t)
• issuing 10 to 46 per year
– EITF YR - #
• some are used frequently
– example EITF 95-22
• “Balance Sheet Classification of Borrowings
Outstanding under Revolving Credit Agreements
That Include both a Subjective Acceleration Clause
and a Lock-Box Arrangement”
• PCAOB PCAOB - Home
FASB’s website
•
•
•
•
•
•
http://www.fasb.org
FASB Pronouncements
Exposure Documents
Comment Letters
EITF
Codification of GAAP
AICPA
• The Accounting Standards Executive
Committee (AcSEC)
– Statements of Positions (SOPs)
• AICPA’s position on issues under the FASB’s
consideration
– Practice Bulletins
Securities & Exchange Commission (SEC)
• has statutory authority to establish financial accounting
and reporting standards for publicly held companies under
the Securities Exchange Act of 1934
– chooses to rely on the FASB to promulgate standards (mostly)
– but may have changed in recent years
• any SEC’s requirements are above the GAAP hierarchy
• Staff Accounting Bulletins (SAB)
– “… reflect the Commission staff's views regarding accountingrelated disclosure practices. They represent interpretations and
policies followed by the Division of Corporation Finance and the
Office of the Chief Accountant in administering the disclosure
requirements of the federal securities laws.”
– also codification of staff accounting bulletins into topics
– Revenue Recognition is a major area
• SAB 101 & SAB 104 & Topic 13
• U.S. Securities and Exchange Commission (Home Page)
Authoritative Financial Literature
• Hierarchy of GAAP previously laid out by
the AICPA in SAS No. 69
• Statement of Financial Accounting
Standards No. 162 issued May 2008
– “The Hierarchy of Generally Accepted
Accounting Principles”
• Statement of Financial Accounting
Standards No. 168 issued June 2009
– replaces FAS 162 and makes the FASB
Accounting Standards Codification the only
authoritative source for GAAP
New Financial Authority
• FASB Accounting Standards Codification
(ASC)
– became authoritative U.S. GAAP on July 1,
2009
• access provided by school
• basic view also available for free
– http://asc.fasb.org/login
Codification of GAAP
• issue of standards overload
– goal is to simplify and codify accounting
standards
• currently 20 sources of GAAP with over 2000
documents
– create a single, authoritative codification of US
GAAP
• replacing authoritative literature issued by FASB,
AICPA, EITF, and SEC
• result in 2 levels of GAAP
– authoritative and non-authoritative
• authoritative
– Levels A through D of the GAAP Hierarchy
» except Level D Practice
Included in Codification
The Codification includes the following literature issued by various standard
setters that apply to all entities (other than governmental entities):
• Financial Accounting Standards Board (FASB)
–
–
–
–
–
–
•
Emerging Issues Task Force (EITF)
–
–
•
•
•
•
•
Statements (FAS)
Interpretations (FIN)
Technical Bulletins (FTB)
Staff Positions (FSP)
Staff Implementation Guides (Q&A)
Statement No. 138 Examples
Abstracts
Topic D
Derivative Implementation Group (DIG) Issues
Accounting Principles Board (APB) Opinions
Accounting Research Bulletins (ARB)
Accounting Interpretations (AIN)
American Institute of Certified Public Accountants (AICPA)
–
–
–
–
Statements of Position (SOP)
Audit and Accounting Guides (AAG)—only incremental accounting guidance
Practice Bulletins (PB), including the Notices to Practitioners elevated to Practice Bulletin
status by Practice Bulletin 1
Technical Inquiry Service (TIS)—only for Software Revenue Recognition
Included in Codification (con’t)
Standards issued by the SEC
• Regulation S-X (SX)
• Financial Reporting Releases
(FRR)/Accounting Series Releases (ASR)
• Interpretive Releases (IR)
• SEC Staff guidance in
• Staff Accounting Bulletins (SAB)
• EITF Topic D and SEC Staff Observer comments.
Codification Indexing
• areas
–
–
–
–
–
–
–
–
presentation (200s)
assets (300s)
liabilities (400s)
equity (500s)
revenue (600s)
expenses (700s)
broad transactions (800s)
industry (900s)
Codification Indexing
• XXX-YY-ZZ-PP
–
–
–
–
XXX is Topic # starting at 100
YY is Subtopic # starting at 10
ZZ is Section # starting at 00
PP is Paragraph # starting at 1
• also subparagraph
– subsections?
• sometimes mentioned but don’t seem to be incorporated into
current version
• exist but not numbered?
• maintaining consistent section #s throughout
– similar to sections used for international accounting
• Section preceded by “S” when it is SEC content
– section 99 used for SEC Materials that are essentially
intact from original source
Codification Indexing
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
XXX-YY-00 Status
XXX-YY-05 Overview and Background
XXX-YY-10 Objectives
XXX-YY-15 Scope and Scope Exceptions
XXX-YY-20 Topical Definitions—Glossary
XXX-YY-25 Recognition
XXX-YY-30 Initial Measurement
XXX-YY-35 Subsequent Measurement
XXX-YY-40 Derecognition
XXX-YY-45 Other Presentation Matters
XXX-YY-50 Disclosure
XXX-YY-55 Implementation Guidance and Illustrations
XXX-YY-60 Relationships
XXX-YY-65 Transition and Open Effective Date Information
XXX-YY-70 Links to Grandfathered Material
XXX-YY-75 XBRL Definitions
Updating
• new authority will be incorporated as
approved
• will be issued in similar format to how
currently issued
– but with appendix of codification updating
instructions
– will be issued a number to track when it was
approved
• YY-XX
– year
– sequential number for the year (01, 02, etc.)
Search Options
• indexing
– area, topic, etc.
• knowing codification section
• knowing current authority and using cross
referencing tool
– very helpful while transitioning
• master glossary
– terms are linkable
– some terms previously defined in a standard are
now defined in the glossary
• acceptable citation “ASC glossary”
Search Options (con’t)
• search
– advance search allows all terms, any terms,
“exact phrase” and within ___ words
– Boolean search allows AND, OR, NOT, “exact
phrase”
• terms must be capitalized
– Narrow by
• related term
• area
Referencing
• FASB ASC {Codification reference}, for
example:
– FASB ASC 310 to reference the Receivables
Topic
– FASB ASC 310-10 to reference the Overall
Subtopic of Topic 310
– FASB ASC 310-10-15 to reference the Scope
Section of Subtopic 310-10
– FASB ASC 310-10-15-2 to reference paragraph
2 of Section 310-10-15
Old GAAP Hierarchy
• SEC requirements are above the GAAP hierarchy
for public companies
• Hierarchy of GAAP (level of authority)
– category (a)
•
•
•
•
•
Statements of Financial Accounting Standards (SFAS or FAS)
FASB Interpretations (FIN)
FASB Statement 133 Implementation Issues
FASB Staff Positions
AICPAs Accounting Principal Board Opinions (APBs)
– that are not superseded by actions of the FASB
• AICPAs Accounting Research Bulletins (ARBs)
– that are not superseded by actions of the FASB
Old GAAP Hierarchy (con’t)
• Hierarchy of GAAP (level of authority)
– category (b)
• FASB Technical Bulletins (FTB)
• AICPA Industry Audit and Accounting Guides
– if cleared by the FASB
• AICPA Statements of Position (SOPs)
– if cleared by the FASB
Old GAAP Hierarchy (con’t)
• Hierarchy of GAAP (level of authority)
– category (c)
• Consensus Positions of the FASB Emerging Issues
Task Force (EITF)
• Topics discussed in Appendix D of EITF Abstracts
(EITF D-Topics)
• AICPA (AcSEC) Practice Bulletins
– if cleared by the FASB
Old GAAP Hierarchy (con’t)
• Hierarchy of GAAP (level of authority)
– category (d)
• AICPA Accounting Interpretations (AIN)
• FASB Implementation Guides (Q&A)
• AICPA Industry Audit and Accounting Guides
– if not cleared by the FASB
• AICPA Statements of Position (SOPs)
– if not cleared by the FASB
• “practices that are widely recognized and prevalent”
Old GAAP Hierarchy (con’t)
• Hierarchy of GAAP (level of authority)
– 1st category (a) then (b)-(d) with (b) higher than
(c), etc.
– if not (a)-(d) then other literature including:
• Statements of Financial Accounting Concepts
(SFAC)
• AICPA Issues Papers
• International Financial Reporting Standards
(IFRSs)
• AICPA Technical Practice Aids
• other items (not required)
Prior Authoritative Financial Literature
• Original Pronouncements
– Accounting Research Bulletins (ARB)
• No. 43 to 51
– 44, 47, 48, 49 & 50 are superseded
– Accounting Principal Board Opinions (APB)
• No. 1 to 31
– 1, 3, 5, 7, 8, 11, 15, 16, 17, 19, 20, 24, 27, 31 are superseded
– AICPA Accounting Interpretations (AIN)
• are interpretations of specific ARBs & APBs
Prior Authoritative Financial (con’t)
• Original Pronouncements (con’t)
– Accounting Principal Board Statements (APS)
• No. 1 to 4
• almost entirely rescinded by AICPA Statements of
Position (SOP)
– Accounting Terminology Bulletins (ATB)
• No. 1 to 4 (1953 - 1957)
Prior Authoritative Financial (con’t)
• Original Pronouncements (con’t)
– Statements of Financial Accounting Standards
(FAS)
• No. 1 to 163
– some superseded
» be certain to check status
– will now issue statements with “R” designation for revised
rather than renumber
» FAS 123R & FAS 132R
– FASB Interpretations (FIN)
• No. 1 to 48
• interpretations of specific statements
Prior Authoritative Financial (con’t)
• Original Pronouncements (con’t)
– FASB Technical Bulletins (FTB)
• number – YR - #
• very few in recent years
– Statements of Financial Accounting Concepts
(CON)
• No. 1 – 7
• No. 6 replaced No. 3
International
• international standards
– IASB Who we are and what we do
• FASB & international convergence
• US GAAP reconciliation requirement
• SEC Roadmap
– No IFRS Requirement Until 2015 or Later Under
New SEC Timeline, Journal of Accountancy
• some differences
• challenges
International Standards
• IASB – International Accounting Standards Board
• IFRS - International Financial Reporting Standards
(No. 1-8)
– prior to 2001 it was the International Accounting Standards
Committee and they issues International Accounting
Standards (IAS) (No. 1- 41, some superseded)
• IFRIC – International Financial Reporting
Interpretations (No. 1-12, some superseded)
– previous SIC (No. 1-32, some superseded)
• http://www.iasb.org/NR/rdonlyres/F9EC8205-E8834A53-9972AD95BD28E0B5/0/WhoWeAreJanuary20102.pdf
Global Use of IFRS
• over 100 (113) countries now require or permit use
of IFRS
– including European Union (EU), Israel, Australia,
South Africa, Singapore, Hong Kong & New Zealand
• EU adopted in 2005
– mandatory for all listed companies
• 2010
– Brazil
• 2011
– Canada, India, Japan & Korea
• http://www.iasplus.com/country/useias.htm
Global Use of IFRS (con’t)
• but countries have separate endorsement
processes and will change aspects of IFRSs
– “as-endorsed” or “as-adopted” versions
– EU requires “compliance with "IFRSs as
adopted by the EU." Currently, the EU has
adopted all IFRSs, though one aspect of IAS 39
was modified.”
Role of IFRS in the capital
markets
• Market capitalization of exchange listed
companies using IFRS
– EU, Australia and Israel – 26% of global
market capitalization
– With Brazil and Canada pending – increases to
approximately 31%
FASB & international convergence
• Norwalk Agreement in 2002
• Memorandum of Understanding between
IASB and FASB in 2006
– sets specific milestones to reach by 2008
– Completion of major joint projects by June
2011
• joint projects
– http://www.fasb.org/intl/convergence_iasb.shtm
l
US GAAP reconciliation
requirement
• foreign private issuers (FPIs)
– international companies registered with the SEC
• Filing 20-Fs
– could file financial statements under US GAAP,
local GAAP or IFRS
– reconciliation to US GAAP required
• stopped requiring reconciliation if reporting
using IFRS
– rule amendments approved by SEC as of Nov. 15,
2007 (effective for years ending after Nov. 15, 2007)
• Financial Accounting Foundation (FAF)
provided an 18 page response on Nov. 7, 2007
US GAAP reconciliation requirement –
FAF response
• need for “U.S. public companies transition to
an improved version of international
accounting standards”
• 4 main points
– investors better served by 1 global standard setter
• “high quality” standards
• a two-GAAP system (US GAAP & IFRS) adds complexity
– FAF, SEC & others need to create a transition plan
• currently developing some joint standards
US GAAP reconciliation requirement –
FAF response
• 4 main points (con’t)
– international cooperation needed
• funding IASB
– independent, sustainable global standard-setting organization
» also global interpretive body
• local variations of IFRS should be eliminated
– eliminate separate review and endorsement procedures
• these 2 points are key to US GAAP converging with IFRS
– remove the requirement to reconcile only if
committed to transition
• now passed without commitment
• propose transitioning via an improve-and-adopt program
SEC Roadmap
• November 14, 2008 issued proposed
roadmap
– 90 day comment period
• Due Feb. 19, 2009
• Extended to April 20, 2009
• Use of IFRS by US Issuers
• http://www.sec.gov/rules/proposed.shtml
• http://www.sec.gov/comments/s7-2708/s72708.shtml
SEC Roadmap – timeline (old)
• 15 December 2009 (fiscal years ending after)
– early adoption by eligible US issuers (limited
early use)
• 15 December 2014 (fiscal years ending after)
– mandatory adoption by large accelerated filers
• 15 December 2015 (fiscal years ending after)
– mandatory adoption by accelerated filers
• 15 December 2016 (fiscal years ending after)
– mandatory adoption by non-accelerated filers
SEC Roadmap (con’t)
• delayed further consideration for 9 months
while SEC focused on financial crisis
• several comments in October 2009
concerning renewed focus on IFRS
SEC Roadmap (con’t)
• February 24, 2010 SEC open meeting to
discuss
• 2015 at the earliest
– with a 2011 vote
– not pursuing early adoption option
• at this time
The statement directs the SEC staff to develop
the plan with the following issues in mind:
• Determining whether IFRS is sufficiently developed and consistent in
application for use as the single set of accounting standards in the U.S.
reporting system.
• Ensuring that accounting standards are set by an independent
standard setter and for the benefit of investors.
• Investor understanding and education regarding IFRS and how it
differs from U.S. GAAP.
• Understanding whether U.S. laws or regulations, outside of the
securities laws and regulatory reporting, would be affected by a
change in accounting standards.
• Understanding the impact on companies both large and small,
including changes to accounting systems, changes to contractual
arrangements, corporate governance considerations and litigation
contingencies.
• Determining whether the people who prepare and audit financial
statements are sufficiently prepared, through education and
experience, to convert to IFRS.
Proposed Roadmap – milestones (old)
• Improvements in accounting standards
• Accountability and funding of IASC
Foundation
• Improvement in Interactive Data (XBRL)
for IFRS reporting
• Education and training
Proposal for limited early use of IFRS –
transition (old)
• For fiscal year ending on or after 15 December
2009
• Starts with annual report on Form 10-K (not
interim reports, registration statements, or
proxy statements)
• Proposal is for three years of audited financial
statements in accordance with IFRS in first
filing
• Requests comment on an alternative: three
years of US GAAP financials and two years of
IFRS in the year of adoption
Proposal for limited early use of IFRS –
eligibility criteria (old)
• If the US issuer is among the 20 largest
companies globally within the industry, and
the industry is an “IFRS industry,” then the
US issuer would be eligible
• Issuer must make a submission to SEC,
providing its analysis
– IFRS (including jurisdictional versions) used by
companies in the top 20
– Timing of analysis
– SEC staff “letter of no objection” – good for three
years
some differences - IFRS
• principal based versus rule based
– more judgment
– US GAAP is more prescriptive with rules
addressing specific transactions
• historical cost versus fair value
– intangible assets, PPE & investment property may
be revalued to fair value
– derivatives, biological assets & certain securities
are revalued to fair value
• no extraordinary items on income statement
• LIFO is prohibited
– US Steel Example
IFRS vs GAAP - leases
ABC enters into an arrangement to lease equipment to
XYZ over a 7 year term. The lease term does not
stipulate title transfer to XYZ at the end of the lease
term, nor does it contain a bargain purchase option. The
estimated useful life of the equipment is 10 years. The
present value of the future minimum lease payments is
89.9% of the fair market value of the equipment at the
lease inception. How should ABC and XYZ account for
the lease in GAAP financial statements and IFRS
financial statements?
A. Financing
B. Operating
C. It depends
IAS 17 – Leases - Summary
• The classification of leases adopted in this
Standard is based on the extent to which risks
and rewards incidental to ownership of a
leased asset lie with the lessor or the lessee.
• A lease is classified as a finance lease if it
transfers substantially all the risks and
rewards incidental to ownership. A lease is
classified as an operating lease if it does not
transfer substantially all the risks and rewards
incidental to ownership.
some differences – IFRS (con’t)
• “high level” convergence in some areas
– Theory is the same
– But can still have differences in specific
application
Sale of Goods
IFRS vs. U.S. GAAP
IAS 18
• Probable future economic
benefits
• Revenue can be measured
reliably
• Costs can be measured
reliably
• Significant risks and rewards
of ownership transferred
• Do not retain managerial
involvement to degree of
ownership nor retain
effective control
SAB 104
• Persuasive evidence of an
arrangement
• Collectibility reasonably
assured
• Price fixed or determinable
• Delivery occurred/services
rendered
Revenue Recognition – Multiple Element
Deliverables
• IAS 18, para. 13 requires separation of elements
– Generally using relative fair value
• IAS 18, para. 19 requires full recognition of revenue
with accrual of costs
• Little guidance on distinction. Generally, would
have same conclusion as U.S. GAAP that
arrangement is multiple element arrangement
– Unlike U.S. GAAP, no equivalent to EITF 00-21 to
determine whether to separate or how to allocate
arrangement consideration to units of accounting
Revenue Recognition – Multiple Element
Deliverables
• Similarities?
– IAS 18 consistent with U.S. GAAP general revenue
recognition guidance (SAB 104). However, U.S.
GAAP has industry or transaction-specific
guidance resulting in differences. Additionally,
guidance on multiple-element arrangements
different. Additional issues to consider:
•
•
•
•
Right of return
Consignment sales
Barter transactions
Agent vs. principal
– compare BP and Exxon / Mobil
What needs to be addressed?
•
•
•
•
•
education and certification
auditing and audit standards
litigation environment
regulatory and contractual requirements
should it be applied to nonpublic and notfor-profit entities?
• SEC accounting and disclosure
requirements
SEC Reporting
10th Power Point
• Securities and Exchange Commission (SEC)
Reporting
– 10-K
– Annual reports to security holders
• ARS
– Definitive Proxy Statement
• DEF-14
–
–
–
–
8-K
10-Q
Forms 3, 4 & 5
20F
• examples
The SEC
• independent regulatory agency of the government
– established to regulate the disclosure of financial
information for publicly traded companies
• Securities Act of 1933
• Securities Exchange Act of 1934
• regulating companies that issue public equity or
public debt (public securities)
– before issuing securities to the public
• prospectus required & Form S-1 or S-3
– after issuing then require 10-Ks, 10-Qs, etc.
10-K
• filed annually
• large accelerated filer
– public float of at least $700 million
• dollar amount of equity securities held by the public
• accelerated filers
– public float of at least $75 million but not $700 million
– has been subject to the SEC’s periodic reporting
requirements for at least 12 months and has filed one
annual report; and
– is not eligible to use SEC’s small business reporting
forms.
• non-accelerated filer
10-K (con’t)
• when file?
– for large accelerated filers
• 75 days
– for years ending before December 15, 2006
• 60 days
– for years ending on or after December 15, 2006
– for accelerated filers
• 75 days
– all others 90 days after end of fiscal year
• March 31 for calendar yearend
10-K (con’t)
• Included Items
– Items might be incorporated by referenced to another
document (annual report or proxy)
– Part I
• Item 1. Business.
– history & description of business, recent developments, principal
products and services, major industry segments
• Item 1A. Risk Factors
• Item 1B. Unresolved Staff Comments
• Item 2. Properties.
– locations and general descriptions of plants and other physical
properties
• Item 3. Legal Proceedings.
– describe pending legal proceedings
• Item 4. Submission of Matters to a Vote of Security Holders.
– describe matters submitted for voting
10-K (con’t)
• Included Items (con’t)
– Part II
• Item 5. Market for Registrant’s Common Equity,
Related Stockholder Matters and Issuer Purchases
of Equity Securities.
– identify the market(s) where common stock traded,
including number of shares, frequency of trading, and
amount of dividends
– also in annual report
• Item 6. Selected Financial Data.
– five-year summary of major financial information (net
sales, income (loss), EPS, total assets, cash dividends, longterm obligations, etc.)
– also in annual report
10-K (con’t)
• Included Items (con’t)
– Part II (con’t)
• Item 7. Management’s Discussion and Analysis of
Financial Condition and Results of Operation
(MD&A).
– discussion of liquidity, capital resources, results of
operations, and impact of inflation
– also in annual report
• Item 7A. Quantitative and Qualitative Disclosures
About Market Risk.
– interest rate, exchange rate, commodity price, etc.
– might be part of MD&A
– also in annual report
10-K (con’t)
• Included Items (con’t)
– Part II
• Item 8. Financial Statements and Supplementary
Data.
– also in annual report
• Item 9. Changes in and Disagreements With
Accountants on Accounting and Financial
Disclosure.
• Item 9A. Controls and Procedures.
– Internal Control over Financial Reporting
» disclosure controls and procedures
» CEO and CFO conclusion
• Item 9B. Other Information.
– 4th quarter 8-K items
10-K (con’t)
• Included Items (con’t)
– Part III
• Item 10. Directors and Executive Officers of the Registrant
– names, ages, and positions of directors and officers
– also in proxy
• Item 11. Executive Compensation.
– salaries, stock options, and other benefits for corporate officers
and selected others
– also in proxy
• Item 12. Security Ownership of Certain Beneficial Owners and
Management
– list of beneficial owners and management owners of corporate
securities
– also in proxy
10-K (con’t)
• Included Items (con’t)
– Part III (con’t)
• Item 13. Certain Relationships and Related Transactions.
– description of transactions with managers and related parties,
and for certain other business relationships
– also in proxy
• Item 14. Principal Accounting Fees and Services.
– audit fees, audit-related fees, tax fees & all other fees
– disclose audit committee pre-approval policies and procedures
– also in proxy
– Part IV
• Item 15. Exhibits, Financial Statements Schedule.
– Signatures
• Certification of Principal Executive Officer &
Principal Financial Officer
Annual Report to Shareholders (ARS)
• Provided annually to shareholders prior to
annual shareholders’ meeting
• Not required to be filed with SEC
– but filed (at least in part) because it includes
information required in 10-K
– also generally available on a company’s web site
• version with photos, graphs, etc.
ARS (con’t)
• Usually includes:
– letter from chief executive officer
– summary financial data
– results of operations
• might be by divisions, product areas, etc.
• want to make company look good
– not regulated by SEC
– financial information (regulated)
•
•
•
•
•
Management Discussion & Analysis (MD&A)
Report of Independent Auditors
Financial Statements
Notes to Financial Statements
corporate information
ARS (con’t)
• Notes to Financial Statements
– always include:
• Significant Accounting Policies
– if applicable (common disclosures):
•
•
•
•
•
•
investments
inventories
leases
property, plant & equipment (PPE)
intangible assets
goodwill
ARS (con’t)
• Notes to Financial Statements
– if applicable (common disclosures):
• long term debt
• short term borrowings, accrued liabilities & other
liabilities
• income taxes
• earnings per share
• stock-based awards (or compensation)
• equity relate disclosures
• employee & retirement benefits
• commitments & contingencies
• business segments
– by product or by geographic
• quarterly financial data (unaudited)
ARS (con’t)
• Notes to Financial Statements
– also include if applicable (less common):
•
•
•
•
•
•
derivative financial instruments
impairment or restructuring
business combination
acquisitions
discontinued operations
subsequent event
Definitive Proxy Statement (Proxy)
• SEC’s form DEF 14A
– required under §14(a) of the Securities
Exchange Act of 1934
• issued to shareholders prior to annual
shareholders meeting
– might also be required to approve a merger or
acquisition (DEFM14A)
• includes information related to items to be
voted on and other required disclosures
Proxy (con’t)
• Board of Directors
– vote for members up for election
• classified
– staggered multiple year terms
• declassified
– all members serve 1 year terms & are reelected every year
– brief biography of directors and executive officers
• independence determined
– committees can include:
• audit
– audit committee financial experts
•
•
•
•
compensation
nominating & governance
finance (less likely)
executive (less likely)
– directors compensation
– corporate governance disclosures
Proxy (con’t)
• Vote on Compensation Plans
–
–
–
–
bonus
stock options
restricted stock
long-term incentive plans (LTIP)
• Executive Compensation
– compensation for the CEO and the next 4 highest paid
executives
• tables summarizing
– salary, bonus, other annual compensation, stock option awards,
restricted stock awards, LTIP payoffs & all other compensation
– long term incentive awards details also provided
• compensation committee report
• Competition
– provide a comparison performance graph
Proxy (con’t)
• Ownership
– who owns 5% or more
– how much is owned by the officers and directors
(management)
• Related Party Transactions
• Auditors
– vote to ratify
– fees paid to auditors
•
•
•
•
audit fees
audit-related fees
tax fees
other fees
– audit committee approval of services
• Shareholders’ Proposals
Examples
•
•
•
•
•
www.sec.gov
a company example
an example of an Annual Report for year ended
an example of a 10-K
an example of a proxy for the shareholders’
meeting
8-K
• update rules effective August 23, 2004
– item numbers were different prior to issuance of these rules
• for what events required?
– Section 1 - Registrant’s Business and Operations
• Item 1.01 Entry into a Material Definitive Agreement
• Item 1.02 Termination of a Material Definitive Agreement
• Item 1.03 Bankruptcy or Receivership
– Section 2 – Financial Information
• Item 2.01 Completion of Acquisition or Disposition of Assets
• Item 2.02 Results of Operations and Financial Condition
• Item 2.03 Creation of a Direct Financial Obligation or an Obligation
Under an Off-Balance Sheet of a Registrant
• Item 2.04 Triggering Events That Accelerate or Increase a Direct
Financial Obligation or an Obligation Under an Off-Balance Sheet
• Item 2.05 Cost Associated With Exit or Disposal Activities
– See FAS No. 146
• Item 2.06 Material Impairments
8-K (con’t)
• for what events required? (con’t)
– Section 3 – Securities and Trading Markets
• Item 3.01 Notice of Delisting
• Item 3.02Unregistered Sales of Equity Securities
• Item 3.03 Material Modification to Rights of
Security Holders
– Section 4 – Matters Related to Accountants and
Financial Statements
• Item 4.01 Changes in Registrant’s Certifying
Accountant
• Item 4.02 Non-Reliance on Previously Issued
Financial Statements or a Related Audit Report or
Completed Interim Review
8-K (con’t)
• for what events required? (con’t)
– Section 5 – Corporate Governance and Management
• Item 5.01 Changes in Control of Registrant
• Item 5.02 Departure of Directors or Principal Officers;
Election of Directors; Appointment of Principal Officers
• Item 5.03 Amendment to Articles of Incorporation or Bylaws;
Changes in Fiscal Year
• Item 5.04 Temporary Suspension of Trading Under
Registrant’s Employee Benefits Plans
• Item 5.05 Amendments to the Registrant’s Code of Ethics, or
Waiver of a Provision of the Code of Ethics
8-K (con’t)
• for what events required? (con’t)
– Section 6 – not yet used
– Section 7 – Regulation FD
• Item 7.01 Regulation FD Disclosure
– Fair Disclosure
– if information is released to one public group (for example
stock analysts) then it has to be released to all of the public
– Section 8 – Other Events
• Item 8.01 Other Events
– Section 9 – Financial Statements and Exhibits
• Item 9.01 Financial Statements and Exhibits
10-Q
• file quarterly
– reviewed not audited
– for large accelerated and accelerated filers
• 40 days
– all others 45 days after end of quarter
10-Q
Excerpt from Regulation S-X
Article 10— Interim Financial Statements
Reg. § 210.10-01.
(d) Interim review by independent public accountant. Prior to
filing, interim financial statements included in quarterly
reports on Form 10-Q must be reviewed by an independent
public accountant using professional standards and
procedures for conducting such reviews, as established by
generally accepted auditing standards, as may be modified
or supplemented by the Commission. If, in any filing, the
company states that interim financial statements have been
reviewed by an independent public accountant, a report of
the accountant on the review must be filed with the interim
financial statements.
10-Q
• Part I - Financial Information
– Item 1 - financial statements (reviewed but unaudited)
• including notes to financial statements
– Item 2 - MD&A
– Item 3 - quantitative & qualitative disclosure about market risk
– Item 4 - controls & procedures
• Part II – Other Information
–
–
–
–
–
–
Item 1 – Legal Proceedings
Item 2 - unregistered sales of equity securities and use of proceeds
Item 3 – defaults upon senior securities
Item 4 - submissions of matters to security holders
Item 5 - other events
Item 6 – exhibits
• Signatures
• CEO & CFO certifications
Forms 3, 4 & 5
• ownership of corporate insiders
– officers, directors and beneficial owners of
more than 10%
– Form 3
• Initial Statement of Beneficial Ownership
– also if no ownership but became officer or director
– Form 4
• Statement of Changes of Beneficial Ownership
– Form 5
• Annual Statement of Changes in Beneficial
Ownership
Examples
• an example of an 8-K
• an example of a 10-Q for quarter ended
• an example of a Form 4
20-F
• filed by foreign private issuers (FPIs)
– issue American Depositary Receipts (ADRs)
• items included
– Item 1 Identify of Directors, Senior Management and
Advisors
– Item 2 Offer Statistics and Expected Timetable
– Item 3 Key Information
– Item 4 Information on the Company
– Item 4A Unresolved Staff Comments
– Item 5 Operating and Financial Review and Prospects
– Item 6 Directors, Senior Management and Employees
– Item 7 Major Shareholders and Related Party Transactions
– Item 8 Financial Information
– Item 9 The Offer and Listing
– Item 10 Additional Information
20-F
• items (continued)
– Item 11 Quantitative and Qualitative Disclosures about Market
Risk
– Item 12 Description of securities other than equity securities
– Item 13 Defaults, Dividend Arrearages and Delinquencies
– Item 14 Material Modifications to the Rights of Security Holders
and Use of Proceeds
– Item 15 Controls and Procedures
– Item 16A Audit Committee Financial Expert
– Item 16B Code of Ethics
– Item 16C Principal Accountant Fees and Services
– Item 16D Exemptions from the Listing Standards for Audit
Committees
– Item 16E Purchases of Equity Securities by the Issuer and
Affiliated Purchases
– Item 17 & 18 Financial Statements
– Item 19 Exhibits
• an example