CTC Documentation & Legal Requirements 3 — Questions and Answers
Question 1: Under the Circular 230 rules, a tax practitioner who discovers a client's error on a previously filed return must:
- File an amended return immediately without informing the client
- Promptly advise the client of the error and its potential consequences (Correct answer)
- Report the error directly to the IRS without the client's consent
- Withdraw from the engagement without any disclosure
Correct answer: Promptly advise the client of the error and its potential consequences
Circular 230 §10.21 requires practitioners to promptly notify the client of noncompliance, error, or omission and advise of the consequences, but does not require the practitioner to report to the IRS.
Question 2: A taxpayer with foreign financial accounts totaling more than $10,000 at any point during the year must file which form?
- Form 8938
- FinCEN Form 114 (FBAR) (Correct answer)
- Form 3520
- Form 5471
Correct answer: FinCEN Form 114 (FBAR)
FinCEN Form 114 (FBAR) must be filed electronically by April 15 (with auto-extension to October 15) when aggregate foreign account balances exceed $10,000.
Question 3: What is the penalty for failure to file a correct information return (e.g., 1099) by the applicable deadline under IRC §6721?
- $50 per return, capped at $500,000 per year for large businesses
- $100 per return, capped at $250,000 for small businesses
- The penalty tiers increase from $50 to $290 per return depending on lateness, with annual caps by business size (Correct answer)
- $1,000 per return with no annual cap
Correct answer: The penalty tiers increase from $50 to $290 per return depending on lateness, with annual caps by business size
IRC §6721 imposes tiered penalties ($50/$110/$290 per return for increasing lateness), with separate annual caps for small and large businesses.
Question 4: A taxpayer claims a charitable contribution deduction of $300 in cash. What is the minimum documentation required?
- A written acknowledgment from the charity
- A bank record or written communication from the charity showing the amount and date (Correct answer)
- No documentation is required for cash donations under $500
- A canceled check and a receipt from the charity
Correct answer: A bank record or written communication from the charity showing the amount and date
For cash contributions under $250, a bank record (canceled check, credit card statement) or written communication from the charity suffices under IRC §170(f)(17).
Question 5: Which document establishes a qualified plan's tax-exempt status and outlines its legal structure for IRS compliance purposes?
- The plan's annual Form 5500 filing
- The plan document and adoption agreement (Correct answer)
- The employer's corporate charter
- The summary plan description distributed to employees
Correct answer: The plan document and adoption agreement
The plan document (and adoption agreement for prototype plans) is the governing legal instrument that defines the plan's terms and must meet IRC §401(a) requirements.
Question 6: When must a taxpayer who is claiming the earned income tax credit (EITC) retain documentation of a qualifying child's residency?
- Only if the IRS audits the return
- For at least 3 years from the filing date in case of IRS inquiry (Correct answer)
- Only during the tax year itself
- For 10 years to match the EITC look-back period
Correct answer: For at least 3 years from the filing date in case of IRS inquiry
Because the IRS can assess EITC errors within 3 years of filing, taxpayers should retain school, medical, and residency records for at least that period.
Question 7: A tax practitioner prepares a return claiming a large research and development credit. Under IRC §41, what documentation is essential to substantiate the credit?
- A general description of the company's industry
- Contemporaneous project records, employee time logs, and supply receipts tied to qualified research activities (Correct answer)
- The CEO's affidavit describing the research broadly
- Only the company's total R&D budget from its financial statements
Correct answer: Contemporaneous project records, employee time logs, and supply receipts tied to qualified research activities
IRC §41 requires that qualified research expenses be traceable to specific projects through contemporaneous records including time allocations and expense receipts.
CTC Documentation & Legal Requirements 3
Under the Circular 230 rules, a tax practitioner who discovers a client's error on a previously filed return must: