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Federal Taxation: Assessing Audit Risk, Tax Evasion

Understanding the US IRC applicable to individual income taxes is important when working with taxation.

Statute of Limitations:

What purpose is served by a statute of limitations? How is it relevant in the case of tax controversies?

Probability of Audit:

Assess the probability of an audit in each of the following independent situations:

As a result of a jury trial, Linda was awarded $3.5 million because of job discrimination. The award included $3 million for punitive damages.

Mel operates a combination check-cashing service and pawnshop.

Jayden, a self-employed trial lawyer, routinely files a Schedule C (Form 1040) that, due to large deductions, reports little (if any) profit from his practice.

Bernard is the head server at an upscale restaurant and recently paid $1.8 million for a residence in an exclusive gated community.

Homer has yearly Adjusted gross income (AGI) of around $70,000 and always claims the standard deduction. He works for a builder installing wallboard in new

Gloria lost a Form 1099-DIV that she received from a corporation that paid her a

Cindy, a former vice president of a bank, has been charged with embezzling large sums of money.

Giselle is a cocktail waitress at an upscale nightclub. She has been audited several times in past years.

Marcus was recently assessed a large state income tax deficiency by the state of California for his utilization of an abusive tax shelter.

Guy, a professional gambler, recently broke up with his companion of ten years and married her teenage daughter.

Role of IRS in Transactions:

A mother sells a valuable collection of antiques to her daughter for $1,000. What judicial concept might the IRS invoke to question this transaction?

Differentiate:

What is the difference between tax avoidance and tax evasion?

Support your responses with examples.

Cite any sources in APA format.

Solution Preview

Statute of Limitations:

What purpose is served by a statute of limitations? How is it relevant in the case of tax controversies?

The main purpose in setting a statute of limitations is to avoid tax consequences from tax years that are many years prior to the resolution date. If a taxpayer files a claim for a refund, the claim for a refund must be within the statute of limitations. The case cannot be argued beyond that point. If the IRS audits a taxpayer, it must also be within the statute of limitations or the IRS cannot collect any monies due from the taxpayer. The protection works in both directions. The time limits exist so that the IRS can no longer assess additional tax, allow a claim for refund by the taxpayer, or take collection action" (Reference - http://www.irs.gov/irm/part25/irm_25-006-001r.html#d0e133)
This prevents a tax controversy carrying out for an unlimited number of years, with no reprieve.

Probability of Audit:
Assess the probability of an audit in each of the following independent situations:

As a result of a jury trial, Linda was awarded $3.5 million because of job discrimination. The award included $3 million for punitive damages.

The problem in this case is not that Linda received punitive damages. It is the amount that she received. An amount of $3.5 million in damages awarded to any recipient would automatically raise red flags for an audit. The likelihood of Linda being audited for that tax year is certain (high).

Mel operates a combination check-cashing service and pawnshop.

The issue in this case is that the business is a check-cashing service and a business (pawnshop) that deals in cash, which can include very large amounts of cash. Years back, there were issues with pawnshops being fronts for embezzlement schemes. Even if illegal activity is not present, any business that deals with large volumes of cash is a high audit risk. The IRS would automatically audit these types of ...

Solution Summary

This solution explains each of the federal taxation questions presented. The statute of limitations is discussed. Each scenario listed is analyzed for audit risk, and the difference between tax avoidance and tax evasion is discussed. This solution also explains the issue surrounding the sale of the antique collection between mother and daughter.

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