Tax procedures — CPA TCP practice questions

In a divorce settlement, a portion of the husband's 401(k) is awarded to the wife to be transferred to her own IRA. The proper mechanism to accomplish this transfer without triggering current income tax or an early withdrawal penalty is:

1. A simple written agreement between the spouses, without any court-related order
2. Treating the transfer as ordinary alimony income to the wife
3. A direct cash withdrawal by the husband, who then gifts the after-tax proceeds to the wife
4. A Qualified Domestic Relations Order (QDRO), allowing tax-free division and rollover to the alternate payee's own IRA

Answer: D — A Qualified Domestic Relations Order (QDRO), allowing tax-free division and rollover to the alternate payee's own IRA

A) Incorrect — a mere private agreement doesn't satisfy plan administrator and tax requirements; a QDRO is a specific court order meeting statutory requirements recognized by the retirement plan. D) Correct — a QDRO allows tax-free division of qualified plan assets in divorce, letting the alternate payee spouse (the wife) roll her awarded share into her own IRA without current taxation or the 10% early withdrawal penalty. C) Incorrect — a direct withdrawal by the husband followed by a gift would trigger immediate taxation (and potentially the 10% penalty) to the husband, defeating the tax-free transfer goal. B) Incorrect — a QDRO transfer is a division of retirement assets, not alimony, and has entirely different tax characterization and mechanics.

A US taxpayer willfully failed to report a foreign bank account and its income for several years and now wants to come forward proactively to minimize criminal exposure. The most appropriate IRS program is:

1. IRS-CI's Voluntary Disclosure Practice (VDP), designed for taxpayers with willful non-compliance
2. The Streamlined Filing Compliance Procedures, designed for non-willful conduct
3. A simple amended return with no special program needed
4. An Offer in Compromise focused solely on penalty reduction

Answer: A — IRS-CI's Voluntary Disclosure Practice (VDP), designed for taxpayers with willful non-compliance

B) Incorrect — Streamlined procedures are specifically for taxpayers whose failure to report was NON-willful; using it for admittedly willful conduct is inappropriate and risky. A) Correct — the Voluntary Disclosure Practice is designed for taxpayers with willful non-compliance (including unreported foreign accounts) to come forward proactively, generally avoiding criminal prosecution in exchange for full cooperation and payment. C) Incorrect — a simple amended return doesn't provide the same protections against criminal referral that VDP offers for willful conduct. D) Incorrect — an OIC addresses settling a liability amount, not the criminal-exposure mitigation goal described.

The individual estimated-tax safe harbor for taxpayers with AGI above $150,000 is:

1. 80% of the current-year tax liability paid quarterly on time
2. 110% of prior-year tax OR 90% of current-year tax paid
3. 100% of prior-year tax regardless of the current AGI level
4. 90% of prior-year tax OR 100% of current-year tax paid

Answer: B — 110% of prior-year tax OR 90% of current-year tax paid

A) 80% is not the statutory threshold. B) Correct — high-AGI safe harbor uses 110%/90%. C) 100% of prior year is only the sub-$150k rule. D) These percentages are reversed from the actual rule.

Form 8938 (FATCA statement) is required by an individual when foreign financial assets:

1. Exceed specified thresholds tied to filing status and year-end value
2. Exceed $10,000 aggregate at any point during the calendar tax year
3. Exceed $250,000 aggregate at any point during the calendar tax year
4. Exceed $50,000 aggregate on the first day of the calendar tax year

Answer: A — Exceed specified thresholds tied to filing status and year-end value

A) Correct — Form 8938 thresholds vary by filing status and residency. B) $10,000 is the FBAR threshold, not Form 8938. C) $250,000 is not the base threshold. D) Beginning-of-year is not the measurement date.

A taxpayer's transaction is found to lack economic substance under §7701(o), resulting in an underpayment of tax. Regarding the accuracy-related penalty applicable to this underpayment, the taxpayer should understand that:

1. The standard reasonable cause exception fully applies, potentially eliminating the penalty entirely
2. A strict liability penalty of 20% (40% if the transaction wasn't adequately disclosed) applies, with NO reasonable cause exception available, unlike most other accuracy-related penalties
3. No penalty applies since economic substance denials only affect the underlying tax benefit, not penalty exposure
4. The penalty is capped at $500 regardless of the underpayment amount

Answer: B — A strict liability penalty of 20% (40% if the transaction wasn't adequately disclosed) applies, with NO reasonable cause exception available, unlike most other accuracy-related penalties

A) Incorrect — this is precisely what makes the economic substance penalty unusual; the standard reasonable cause defense that applies to most accuracy-related penalties is specifically UNAVAILABLE for economic substance doctrine violations. B) Correct — underpayments attributable to a transaction lacking economic substance are subject to a strict liability penalty of 20% (increased to 40% if the transaction lacked adequate disclosure), and critically, there is NO reasonable cause exception available for this specific penalty, unlike the general accuracy-related penalty regime which typically allows a reasonable cause and good faith defense. C) Incorrect — a real penalty (not just benefit denial) specifically applies to underpayments from economic-substance-lacking transactions. D) Incorrect — the penalty is percentage-based (20% or 40% of the underpayment), not capped at a small flat dollar amount.

A taxpayer made her first-ever Roth IRA contribution in 2020 and separately converted traditional IRA funds to Roth in 2023. She wants to withdraw the 2023 converted principal in 2024, before age 59½, without penalty. Regarding the Roth five-year rules, she should understand that:

1. A single five-year clock governs both the tax-free treatment of earnings and the penalty-free treatment of converted principal, both starting from her 2020 contribution
2. Two SEPARATE five-year clocks apply: the earnings-qualification clock runs from her first-ever contribution (2020), while the conversion-specific penalty clock runs separately for EACH conversion (2023, in this case) — meaning her 2023 conversion hasn't yet cleared its own 5-year penalty clock
3. Roth conversions are always subject to ordinary income tax and penalty regardless of any five-year rule
4. The five-year rule applies only to traditional IRAs, never to Roth IRAs

Answer: B — Two SEPARATE five-year clocks apply: the earnings-qualification clock runs from her first-ever contribution (2020), while the conversion-specific penalty clock runs separately for EACH conversion (2023, in this case) — meaning her 2023 conversion hasn't yet cleared its own 5-year penalty clock

A) Incorrect — while the OVERALL contribution 5-year clock (from her first-ever Roth contribution/conversion) does track the qualification for tax-free EARNINGS withdrawals, each CONVERSION separately carries its OWN 5-year clock for penalty-free withdrawal of the CONVERTED PRINCIPAL specifically — these are two distinct rules, not a single unified clock. B) Correct — the contribution 5-year clock (from 2020, her first Roth activity) governs qualified tax-free treatment of EARNINGS, while a SEPARATE conversion-specific 5-year clock applies to each individual conversion for early-withdrawal-penalty purposes on the converted PRINCIPAL — her 2023 conversion has its own independent 5-year clock that hasn't run yet as of a 2024 withdrawal, potentially triggering the 10% early withdrawal penalty on that converted principal even though her overall Roth account is well past its initial 5-year mark. C) Incorrect — this ignores the nuanced five-year rules that specifically CAN provide favorable tax and penalty treatment when properly satisfied. D) Incorrect — the five-year rules described here are specifically Roth IRA rules, not traditional IRA rules.

Estate tax portability requires the executor of the first-deceased spouse to:

1. File a timely Form 706 electing portability, even if no estate tax is due
2. File a timely Form 709 electing portability, even if no gift tax is due
3. File Form 1040-X for the surviving spouse to claim portability retroactively
4. Take no action; portability is automatic under current federal estate rules

Answer: A — File a timely Form 706 electing portability, even if no estate tax is due

A) Correct — Form 706 with a timely portability election. B) Form 709 is the gift-tax return. C) Individual returns do not effect portability. D) Portability is not automatic.

A family has significant unused funds remaining in a 529 plan that has been open for over 15 years, with the named beneficiary having completed her education without using all the funds. Under SECURE 2.0, this family may now be able to:

1. Withdraw the funds entirely tax-free for any purpose whatsoever
2. Roll a limited amount of the unused 529 funds into the beneficiary's own Roth IRA, subject to the annual Roth contribution limit and a $35,000 lifetime cap
3. Only close the account and pay full ordinary income tax plus a 10% penalty on the entire balance with no other option
4. Transfer the funds to any unrelated third party's Roth IRA without any beneficiary restriction

Answer: B — Roll a limited amount of the unused 529 funds into the beneficiary's own Roth IRA, subject to the annual Roth contribution limit and a $35,000 lifetime cap

A) Incorrect — using 529 funds for a non-qualified purpose (unrelated to education or this new rollover provision) would trigger income tax and typically a 10% penalty on the earnings portion; there's no blanket tax-free withdrawal for any purpose. B) Correct — SECURE 2.0 created a new option beginning in 2024 allowing a 529 account open for at least 15 years to roll unused funds into the BENEFICIARY's own Roth IRA, subject to the annual Roth contribution limit for that year and an overall $35,000 lifetime cap on such rollovers — a valuable option for overfunded accounts. C) Incorrect — this ignores the new SECURE 2.0 rollover option, which provides a more tax-efficient alternative to a full nonqualified withdrawal. D) Incorrect — the rollover option is specifically limited to the 529 account's own designated BENEFICIARY's Roth IRA, not transferable to any unrelated third party.

A tax shelter promoter makes false statements about the tax benefits of an investment and grossly overvalues the underlying property to investors. Under §6700, this promoter faces:

1. No penalty, since §6700 applies only to the investors, not the promoter
2. A penalty generally equal to the lesser of a percentage of the gross income derived from the activity or a flat statutory amount per activity
3. Automatic criminal prosecution with no civil penalty alternative
4. A penalty capped at $100 regardless of the scale of the abusive shelter

Answer: B — A penalty generally equal to the lesser of a percentage of the gross income derived from the activity or a flat statutory amount per activity

A) Incorrect — §6700 is specifically directed at the PROMOTER/organizer/seller of the abusive shelter, not the investors who purchased into it (though investors may face their own separate consequences, like disallowed deductions and accuracy-related penalties). B) Correct — §6700 imposes a penalty on promoters who make false or fraudulent statements about tax benefits, or who grossly overvalue property in connection with an abusive tax shelter, with the penalty generally computed as the lesser of a percentage of the gross income derived from the activity or a flat statutory dollar amount per activity. C) Incorrect — §6700 is a CIVIL penalty provision; while separate criminal statutes could potentially also apply to egregious conduct, §6700 itself doesn't mandate automatic criminal prosecution. D) Incorrect — the penalty is calculated based on gross income from the activity (or a statutory flat amount), which can be substantial for large-scale abusive shelters, not capped at a trivial $100 figure.

A taxpayer facing an IRS audit of a reportable transaction that was NOT properly disclosed on Form 8886, combined with a substantial understatement of tax, should expect exposure to which combination of penalties, assuming no reasonable cause defense is established?

1. Both the §6707A penalty for failure to disclose the reportable transaction and the §6662 accuracy-related penalty for the substantial understatement, since they address different failures
2. Only the §6707A disclosure penalty, since the accuracy-related penalty cannot apply to the same transaction
3. No penalties, since the taxpayer already faces additional tax on the merits
4. Only criminal penalties, since civil penalties never apply to reportable transactions

Answer: A — Both the §6707A penalty for failure to disclose the reportable transaction and the §6662 accuracy-related penalty for the substantial understatement, since they address different failures

B) Incorrect — these are separate penalty regimes addressing separate failures (non-disclosure vs. the understatement itself), and both can apply. A) Correct — §6707A penalizes the failure to disclose a reportable/listed transaction regardless of its merits, while §6662 separately penalizes the substantial understatement of tax; absent reasonable cause or adequate disclosure defenses, both can be assessed together since they target different compliance failures. C) Incorrect — additional tax owed doesn't preclude separate penalty exposure. D) Incorrect — civil penalties like §6707A and §6662 routinely apply to reportable transactions; criminal penalties are a separate, higher-bar matter.

Tax controversy — IRS audit representation?

CPAs with a PTIN can represent clients in audits for returns they prepared under limited practice rights; EAs/CPAs/attorneys have unlimited representation rights under Circular 230.

Form 7004 extension for businesses?

Grants an automatic 6-month extension (5.5 months for some calendar-year partnerships/trusts) for various business returns (1120, 1120-S, 1065, etc.) — like Form 4868, extends filing time only, not payment time.

Economic substance doctrine — strict liability penalty?

A 20% penalty (40% if not disclosed) applies to underpayments attributable to a transaction lacking economic substance, with NO reasonable cause exception available — unlike most other accuracy-related penalties.

Estimated tax safe harbor?

Pay 100% of prior year tax (110% if AGI >$150k) OR 90% of current year. Avoid underpayment penalty.