Updates and guidance on key IRS practice developments.
Transcript of account issued by the IRS
The Internal Revenue Manual (IRM) contains the procedures for all areas the IRS administers. It includes matters such as policies for information technology, submission processing, Examination and Collection processes, Appeals, Criminal Investigation, and the Taxpayer Advocate Service. The manual is available on irs.gov.
Information-processing procedures are found in Part 3 of the IRM. Among other materials, the section provides instructions for coding and editing tax returns for computer processing. Special codes are used in performing specific functions.
An individual master file (IMF) is used to record transaction and financial entries for individual tax returns. Its counterpart is the business master file (BMF) for business returns.
The IRS maintains a transcript of account for each filed tax form. A transcript shows most entries on a tax return. It includes data on an amended tax return, payments, penalties, and other processing activities.
A transcript may be obtained online at the IRS website by first registering at Get Transcript Online and then ordering the document for the appropriate taxpayer. If a person does not want to get an online transcript, a call may be made to 800-908-9946 to request that one be mailed. A person who has a power of attorney may call the Practitioner Priority Service at 866-860-4259.
Often, an authorized tax practitioner will request a transcript for a client to find what information was reported on a prior-year return, to respond to an IRS notice, to find what action was taken on an amended return, or to check the status of a claim for refund or status of the processing of Form 1045, Application for Tentative Refund.
When a transcript is obtained, it is important to know the meaning of transaction codes shown on the form. Document 11734, Transaction Codes Pocket Guide, which is issued by the Service, should be read for an abbreviated listing of the commonly used codes. A complete listing of the codes is in Document 6209, IRS Processing Codes and Information; however, some information in that publication is redacted.
The chart on the next page contains a list of common codes and their titles.
By knowing the applicable codes, practitioners should more easily be able to determine if the IRS has correctly processed returns and has taken the correct actions on events subsequent to the filing of returns. Thus, practitioners will be providing quality service to clients.
From Joe Marchbein, CPA, CGMA, Ellisville, Mo.
Items and factors to consider in setting reasonable compensation
Whether amounts paid by businesses to shareholder-employees qualify as deductible compensation or should be characterized as distributions or gifts has long been a source of tax controversy, one that often requires a careful analysis of all facts and circumstances to establish the correct characterization of the payments. To appropriately perform this analysis, all companies should maintain supporting documentation for the payments. Compensation for higher-paid employees and executives is especially at risk of IRS scrutiny.
Sec. 162 provides that only ordinary and necessary expenses incurred in carrying on a trade or business are deductible. Regs. Sec. 1.162-7(a) sets forth two requirements for compensation payments to be deductible, stating, "The test of deductibility in the case of compensation payments is whether they are reasonable and are in fact payments purely for services."The amount of compensation may be considered reasonable if it is similar to that paid for like services by like enterprises under like circumstances. Factors in determining similar enterprises would include characteristics such as sales, growth, performance, and value. The amount of the compensation alone is insufficient.
Court cases have held that if the purported compensation is a distribution of profits, it is not compensation but is instead a dividend. However, payment for bona fide services rendered to the company should qualify to be classified as compensation. For it to be considered payment for services, one needs to consider multiple factors, such as the employee's qualifications; the employee's duties; the employee's background and experience; the employee's knowledge of the business; the size and complexity of the company; the employee s time devoted to the company; and the company's economic condition, both currently and in prior periods.
Some resources that might be helpful in making a determination include the Willis Towers Watson General Industry Compensation Policies and Practices Survey Report, the Economic Research Institute's compensation analysis services, and the Risk Management Associates Annual Statement Studies, which are all published annually.
Several court decisions may also be pertinent. O.S.C. & Associates, Inc., 187 F.3d 1116 (9th Cir. 1999), addressed what the court found to be "overwhelming evidence" that the taxpayer's intent was to distribute profits and not to pay compensation for services. For reasonableness of the amount of compensation, see also Owensby & Kritikos, Inc., 819 F.2d 1315 (5th Cir. 1987); Rapco, Inc., 85 F.3d 950 (2d Cir. 1996); and H. W. Johnson, Inc.,T.C. Memo. 2016-95. Mayson Manufacturing Co., 178 F.2d 115 (6th Cir. 1949), and Miller & Sons Drywall, Inc.,T.C. Memo. 2005-114, described recognized methods using a multifactor approach for determining when compensation is reasonable. Cases that review whether amounts paid represented compensation for services performed prior to the tax year at issue include American Foundry, 59 T.C. 231 (1972), and Perlmutter, 44 T.C. 382 (1965). R.J. Nicoll Co., 59 T.C. 37 (1972), demonstrates that the burden of proving proper compensation is with the taxpayer.
Publicly traded companies often have reference thresholds, compensation committees, transparency in their SEC reporting requirements, Sec. 162(m) requirements regarding annual compensation exceeding $1 million, and other disclosure requirements, all of which can aid in determining the reasonableness of their compensation policies. Privately held companies often do not have as much data regarding compensation available, making compensation issues more vulnerable to controversy.
According to a 2014 internal IRS guide Reasonable Compensation: Job Aid for IRS Valuation Professionals ("Job Aid"), reasonable compensation levels are typically analyzed by the market approach, the income approach, and the cost approach. The market approach is the most commonly used and is generally favored by courts, the Job Aid states.
The facts and circumstances surrounding a payment are key to determining whether any or all of a payment is classified properly as compensation. For closely held companies established as C corporations, the concern is the payment of excessive compensation to shareholder-employees. S corporations, on the other hand, are concerned with the possible underpayment of compensation to their shareholder-employees, which allows the S corporation to avoid payroll and unemployment taxes.
CPAs should consider advising their business clients to hire a valuation analyst. A valuation analyst can analyze the reasonableness of a closely held corporation's compensation of shareholder-employees. Benefits of engaging a valuation analyst include that an independent third-party analysis should provide greater support to the reasonableness of compensation amounts in any IRS examination. Also, an analyst could provide expertise for other, nontax considerations regarding compensation, including owner transition, litigation, and corporate governance. An analyst report would become part of the documentation supporting compensation levels.
Higher and lower compensation amounts are much more difficult to compare when looking at privately held companies. Issues of unreasonably high compensation could arise, for example, when a company pays a family member employee more than the services performed are worth. The business then tries to claim a tax deduction for what should be considered a gift to that family member, potentially creating a secondary gift tax issue. Compensation may also be unreasonably high because it includes amounts that should be dividends to the shareholder-employees. In addition, unreasonably high compensation may be used to increase the amount that can be contributed to shareholder-employee retirement plans, such as SEPs or Keoghs.
Similarly, in the context of S corporations, compensation amounts that appear lower than under comparable circumstances could nonetheless be reasonable if they reflect, for example, an employee's reduced role in retirement or the company's economic constraints. Compensation is likely to be considered unreasonably low, however, if it results from a shareholder-employee's desire to avoid paying higher employment taxes by receiving a relatively low salary but with relatively large distributions. Besides exposing the company to additional payroll taxes, penalties, and interest if the IRS detects it, this tactic could also negatively affect the Social Security earnings of the shareholder-employee for retirement. Other, broader questions could also be in play if compensation is unreasonably low. For example, it could devalue the services provided by an employee, which in turn could negatively impact a future sale of the company, hiring new executives, etc. Unreasonably low compensation could also affect an employee-shareholder's employee health insurance eligibility.
Compensation will continue to be an area of controversy. Whether they are publicly traded or privately held, entities will continue to struggle with the possibility of having to justify their compensation levels. Companies need to properly document all facts, circumstances, and strategies used to reach the compensation levels paid for a given year.
This item was prepared with Donna Sauter, CPA, who is a member of the AICPA Tax Practice and Procedures Committee.
From Robert M. DiGiantommaso, CPA, Walpole, Mass.
Tax reform alert
As this issue went to press, Congress was considering tax reform legislation that, if enacted, could affect the treatment of compensation as discussed in this item.
Form 8879: Requirements, possible problems, and best practices for practitioners
CPAs have become familiar with the electronic filing requirements and filing Form 8879, IRS efile Signature Authorization, especially since the IRS has mandated e-filing for almost all tax practitioners. This requirement, in effect, has added one more step to the tax preparation process for practitioners. Instead of being able to mark a return as "complete" once it was printed and delivered to the client to mail, the responsibility of submitting the tax return now is with practitioners, and a preparer has not truly completed the process until the tax return is electronically transmitted and accepted by the IRS or state filing authorities.
Thus, CPAs face issues that did not exist a decade ago, since now they must ensure that they receive signed authorizations from clients before electronically submitting tax returns. That is where the Form 8879 series comes in. Form 8879 is used for Form 1040, U.S. Individual Income Tax Return; Form 8879-PE, IRS efile Signature Authorization for Form 1065; Form 8879-C, IRS efile Signature Authorization for Form 1120; and Form 8879-S, IRS efile Signature Authorization for Form 1120S.
Each filing season, practitioners have concerns about what their requirements and responsibilities are for these forms and for the electronic submission of their clients' tax returns. In most cases, a CPA firm is the Electronic Return Originator (ERO), which is the authorized e-file provider originating the electronic submission of a return to the IRS. The ERO's responsibility is separate from that of tax return preparation, but it must comply with several requirements, including the following:
* Timely originating the electronic submission of returns;
* Submitting any required supporting paper documents to the IRS;
* Providing copies of tax returns to the taxpayer; and
* Retaining records and making records available to the IRS if requested.
In e-filing returns for their clients, CPAs generally use the practitioner PIN method, which allows the ERO to enter a personal identification number (PIN) or generate a PIN for the taxpayer, and while e-signature options are now available to obtain digital signatures from the taxpayer, in most cases, a Form 8879 is required to be printed and signed by both the ERO and the taxpayer before the return is submitted to the IRS. The Form 8879 contains a taxpayer declaration that the taxpayer must sign and date, stating that he or she has reviewed the tax return and has ensured the tax return information of the Form 8879 matches the information on the return. That declaration and signature authorization on Form 8879 gives the ERO permission to electronically submit the return.
In light of these requirements, what can go wrong with the process? As CPAs can attest, it seems that every filing season something does.
Problem No. 1: Failure to send a copy of the tax return to the taxpayer with Form 8879
Technology is an ever-increasing part of a CPA's daily life, as are deadlines. Clients submit tax information via email, fax, or a secure client portal. Often that information can come in with little time to spare, so being able to deliver a copy of the client's tax return personally or by mail may be difficult. Clients can be anxious to get their tax returns submitted with deadlines approaching quickly, so they may request that the practitioner send the Form 8879 electronically so that it can be signed and the return submitted promptly.
However, as stated above, the ERO is required to provide a copy of the return to the client, and the disclosure that the client signs on the Form 8879 states that he or she has reviewed the tax return before signing the form. So, while it may be tempting for a CPA to quickly email the Form 8879 to the client, especially under pressure from a client who assures the practitioner that "it will be fine," the practitioner should always send an electronic copy of the complete tax return along with the Form 8879 so the client can review the return before signing Form 8879.
If the ERO is also the tax preparer, failure to provide the return could result in preparer penalties being assessed under Secs. 6694 and 6695. Under Sec. 6695(a), the penalty for failure to furnish a copy of the return is $50 for each failure to comply, unless the failure is due to reasonable cause and not willful neglect. A maximum penalty of $25,500 applies based on all documents filed during a calendar year. Even if the ERO is not considered the tax preparer, the practitioner is at risk for sanctions for violating ERO regulations, as explained below, and could possibly lose the ability to participate in the IRS e-file program. Such sanctions would severely impact the CPA's ability to practice.
Problem No. 2: Failure to obtain signed Form 8879 before submitting the return
The practitioner does not have authorization to electronically submit the return until a signed Form 8879 is received. The taxpayer's signature should be dated on or before the date the ERO submits the return. The IRS requires the ERO to transmit the return for e-filing within three days of receiving the signed Form 8879. A client may be out of town and unable to receive mail or may not have access to email, or fax or scanning capabilities. Often a client will give verbal instructions to the CPA to transmit the returns.
While it may be tempting for the practitioner to take the verbal authorization from the client, the practitioner should be aware that this violates the ERO regulations. These IRS requirements for e-filing must be adhered to by practitioners, and CPAs should also consider other applicable ethics standards, such as those under Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), the AICPA Code of Professional Conduct, and the AICPA Statements on Standards for Tax Services. Clearly, the failure to get signed authorizations from clients could put the ERO status at risk, so CPAs should make every effort to have a signed Form 8879 in hand before transmitting the return.
Problem No. 3: Failure to keep signed Forms 8879 on file
EROs are required to keep the signed Forms 8879 on file for three years after the date the return was received by the IRS or the due date of the return, whichever is later. If these recordkeeping rules are not complied with, the ERO is subject to IRS sanctions, as mentioned above. In its monitoring of EROs, the IRS categorizes infractions as level one, two, or three (see Internal Revenue Manual [section]126.96.36.199.11, Levels of Infractions), and an ERO is subject to written reprimand, suspension, or expulsion from the IRS e-file program depending on the seriousness of the infraction. This monitoring is done through visits to providers' offices. IRS Publication 3112, IRS e-file Application and Participation, explains these types of infractions and the actions that may be taken.
Problem No. 4: Concerns about signatures on Form 8879
The taxpayer declaration on the Form 8879 series of forms must be signed by a person authorized to sign tax returns for the taxpayer. For a corporation, that would be an officer of the company. For a partnership, it would be a general partner or managing member. For individual returns, the authorization must be given by the taxpayer or by both the taxpayer and spouse if filing a joint return. CPAs may be questioned as to who can sign an authorization, so they should be aware of some special cases in which a taxpayer can sign Form 8879 for someone else.
If the taxpayer is deceased, the Form 8879 can be signed by the executor or administrator of the decedent's estate. A taxpayer can sign his or her spouse's name if the spouse is unable to sign due to injury, disease, or deployment in a combat zone, and verbal permission is given. A taxpayer who has a power of attorney (POA) can also sign returns on behalf of someone else, although care should be taken that the POA clearly authorizes the person to sign tax returns. Otherwise, Form 2848, Power of Attorney and Declaration of Representative, must be used. A parent can sign on behalf of a dependent child if the child is not old enough to sign the return. Unless these exceptions apply, the Form 8879 must be signed by the taxpayer and spouse if applicable. Practitioners are not required to be present when the Forms 8879 are signed, but they should advise clients to ensure that proper signatures are obtained by all parties.
There are options for e-signature of tax returns, and practitioners may find that getting those digital signatures is more efficient than having to get a paper Form 8879 signed. In March 2014, the IRS updated policies to allow for e-signatures. Practitioners should consult IRS Publication 1345, Handbook for Authorized IRS e-File Providers of Individual Income Tax Returns, for more details regarding the acceptable methods of digital signatures allowed, and the additional steps that practitioners must take each year to authenticate the taxpayer's name, Social Security number, address, and date of birth.
Whether a tax preparer is a sole practitioner or a large firm, policies and procedures should be in place to ensure that all IRS requirements for EROs are met. Publication 1345 is a good resource to develop best practices in this area. In addition, since all aspects of the e-filing of tax returns inevitably require the use of technology, practitioners should also be mindful of email protocols and client security issues, and sensitive information that could be sent electronically when emailing or faxing tax returns and/or Forms 8879.
Practitioners should ensure that the tax preparation software they use is up to date in providing security and privacy of client information. And, finally, the practitioner should use the e-filing process as a tool to educate clients. The tax system is complicated, and many clients may not be able to understand the system's complexities--that is why they hire CPAs. However, if a client better understands the tax return and his or her responsibilities, there is less risk of miscommunication with the practitioner. And reviewing tax returns with clients each year could lead to more compliant clients, making the CPA happier and resulting in more long-term, successful client relationships.
From Jan F. Lewis, CPA, Jackson, Miss.
Editor: Valrie Chambers, CPA, Ph.D.
Valrie Chambers is an associate professor of accounting at Stetson University in Celebration, Fla. Joe Marchbein is with Rice Sullivan LLC in Ellisville, Mo. Robert M. DiGiantommaso practices in Walpole, Mass. Jan Lewis is a tax partner with Haddox Reid Eubank Berts PLLC in Jackson, Miss. Mr. Marchbein and Mr. DiGiantommaso are members and Ms. Lewis is immediate past chair of the AICPA Tax Practice and Procedures Committee. For more information about this column, contact firstname.lastname@example.org.
Common IRS transaction codes Transaction code Title 013 Name Change 014 Address Change 017 Spouse SSN 076 Acceptance of Form 8832, Entity Classification Election 078 Rejection of Form 8832, Entity Classification Election 079 Revocation of Form 8832, Entity Classification Election 090 Small Business Election 091 Terminate Small Business 150 Return Filed & Tax Liability Assessed 166 Delinquency Penalty 170 Estimated Tax Penalty 186 FTD (Deposit) Penalty Assessment 196 Interest Assessed 240 Miscellaneous Penalty 276 Failure to Pay Tax Penalty 290 Additional Tax Assessment 336 Interest Assessment on Additional Tax or Deficiency 420 Examination Indicator 460 Extension of Time for Filing 470 Taxpayer Claim Pending 480 Offer-in-Compromise Pending 494 Notice of Deficiency 582 Lien Indicator 610 Remittance with Return 660 Estimated Tax 670 Subsequent Payment 800 Credit for Withheld Taxes 840 Manual Refund
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|Publication:||The Tax Adviser|
|Date:||Jan 1, 2018|
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