CPA's Tax Practice

Tax Practice

The RIGOS Loss Prevention manual contains recommended language implementing all the below considerations (and much more). The Bar Associations and Societies in some states and countries do not allow such web postings since they may constitute legal advice and be used by non-Rigos clients or non-Rigos seminar attendees. If you are interested in receiving a brochure covering such items, send us an e-mail at www.losscontrolforcpas.com.

Clients' claims against CPAs for penalties, tax overpayments and lost tax opportunities are now the leading cause of malpractice claims. In addition, the CPA may be directly liable to the IRS as a tax return preparer under the Treasury Department's Publication 230. The AICPA has a different, and often lower, set of standards than the Treasury Department. CPAs must also comply with the AICPA's Statements on Tax Practice.

I. AICPA RESPONSIBILITIES OF TAX PRACTICE

The responsibilities of a CPA in the tax practice area are spelled out in a series of Statements of Responsibility in Tax Practice (SRTPs) issued by the Tax Executive Committee of the AICPA. The most recent edition is the 1991 revision. These statements are intended to be guides to professional practice, and should be considered in addition to all relevant regulations and rules governing tax practice promulgated by Federal and State tax authorities. The standards are considered to be applicable to all aspects relating to Federal tax practice.

A. SRTP 1 Tax Return Positions Contrary to I. R. S.

With respect to tax return positions, a CPA should comply with the following standards:

· A CPA should not recommend to a client that a position be taken with respect to the tax treatment of any item on a return unless the CPA has a good faith belief that the position has a realistic possibility of being sustained administratively or judicially on its merits if challenged.

· A CPA should not prepare or sign a return as an income tax preparer if the CPA knows that the return takes a position that the CPA could not recommend under the standard expressed in the paragraph above.

· Notwithstanding the two paragraphs above, a CPA may recommend a position that the CPA concludes is not frivolous so long as the position is adequately disclosed on the return or claim for refund.

· In recommending certain tax return positions and in signing a return on which a tax return position is taken, a CPA should, where relevant, advise the client as to the potential penalty consequences of the recommended tax return position and the opportunity, if any, to avoid such penalties through disclosure.

The CPA should not recommend a tax return position that

· Exploits the Internal Revenue Service audit selection process; or

· Serves as a mere "arguing" position advanced solely to obtain leverage in the bargaining process of settlement negotiation with the Internal Revenue Service.

The CPA has both the right and responsibility to be an advocate for the client with respect to any positions satisfying the aforementioned standards.

The AICPA recognizes the CPA is an advocate for the client. The duty is to arrive at the legal minimum tax possible in accordance with the above standards. The CPA must have a good-faith belief that a controversial tax position will be sustained if questioned under audit. Disclosure on the return is advised and the client should make the ultimate decision.

B. SRTP 2 Answers to Questions on Tax Returns

A CPA should make a reasonable effort to obtain from the client, and provide, appropriate answers to all questions on a tax return before signing as preparer.

A CPA must make a reasonable effort to find out the answers to all questions on the tax return. The basis for not answering questions should be limited to situations where:

1. Not Available: The information is not available, and the answer is not significant in terms of determining taxable income;

2. Uncertainty: Uncertainty exists regarding the meaning of the question;

3. Unreliability: The information obtainable is unreliable;

4. Too Voluminous: The answer is too voluminous.

Where the answer is omitted, a brief explanation of the omission should be provided on the return.

C. SRTP 3 Relying on Client Information

In preparing or signing a return, the CPA may in good faith rely without verification upon information furnished by the client or by third parties. However, the CPA should not ignore the implications of information furnished and should make reasonable inquiries if the information furnished appears to be incorrect, incomplete, or inconsistent either on its face or on the basis of other facts known to the CPA. In this connection, the CPA should refer to the client's returns for prior years whenever feasible.

Where the Internal Revenue Code or income tax regulations impose a condition with respect to deductibility or other tax treatment of an item (such as taxpayer maintenance of books and records or substantiating documentation to support the reported deduction or tax treatment), the CPA should make appropriate inquiries to determine to his or her satisfaction whether such condition has been met.

The individual CPA who is required to sign the return should consider information actually known to that CPA from the tax return of another client when preparing a tax return if the information is relevant to that tax return, its consideration is necessary to properly prepare that tax return, and use of such information does not violate any law or rule relating to confidentiality.

Statement 3 allows the CPA rely on client supplied information in the preparation of a return as long as it appears reasonable on its face. The CPA should urge the client to provide supporting data where appropriate. It is not usually necessary to audit the taxpayer's source documents. An accountant may also accept the characterization of income and expense items on third party source documents such as W2s, 1099s, K1s, etc. The CPA should make reasonable inquiries where he believes the information presented is incorrect or incomplete.

D. SRTP 4 Use of Estimates

A CPA may prepare tax returns involving the use of the taxpayer's estimates if is it impracticable to obtain exact data, and the estimated amounts are reasonable under the facts and circumstances known to the CPA. When the taxpayer's estimates are used, they should be presented in such a manner as to avoid the implication of greater accuracy than exists.

This statement allows the use of estimates in lieu of actual amounts, if:

1. Generally Acceptable: Such use is generally acceptable among CPAs;

2. Impracticality: It is not practical to obtain exact data;

3. Reasonable: The estimate appears reasonable under the circumstances.

E. SRTP 5 Departure From a Position Previously Concluded in an Administrative Proceeding or Court Decision

A CPA generally recommends a position concerning treatment of a given item for tax purposes that is consistent with an administrative position or court decision. The CPA can recommend a tax return position that is not consistent, but in making that decision should take into consideration the following factors:

Neither the IRS nor the taxpayer is required to act consistently with the results of the prior administrative proceeding. However, the IRS tends to act consistently with those results.

A court decision concerning a given tax position may not prevent the taxpayer from taking a position in a subsequent year that is inconsistent with that decision.

The previous administrative proceeding or court decision should be taken into consideration when evaluating whether the Realistic Possibility Standard has been met.

The previous administrative proceeding or court decision may have been based on a lack of documentation, but documentation is adequate for the item in question for the subsequent year.

The taxpayer may have decided not to challenge the previous administrative proceeding or court decision even though the position met Standard SRTP 1.

Court decisions or administrative findings more favorable to the taxpayer's position may have developed subsequent to the previous administrative proceeding or court decision concerning the item in question.

The thrust of this statement is that a CPA must be able to distinguish the current situation from the previous administrative proceeding or court decision. A significant factual difference may qualify. In addition, the law may have developed such that a new court decision may apply. Perhaps it would be prudent to get a tax attorney's opinion letter.

F. SRTP 6 Knowledge of Error in Return Preparation

The CPA should inform the client promptly upon becoming aware of an error in a previously filed return or upon becoming aware of a client's failure to file a required return. The CPA should recommend the measures to be taken. Such recommendation may be given orally. The CPA is not obligated to inform the Internal Revenue Service, and the CPA may not do so without the client's permission, except where required by law.

If the CPA is requested to prepare the current year's return and the client has not taken appropriate action to correct an error in a prior year's return, the CPA should consider whether to withdraw from preparing the return and whether to continue a professional relationship with the client. If the CPA does prepare such a current year's return, the CPA should take reasonable steps to ensure that the error is not repeated.

Statement 6 provides for the following four procedural steps:

1. Notify Client: The client should be notified of the error, and informed as to the steps necessary to correct it. This usually means amending or filing a return.

2. Client Decision: The client can decide whether or not to correct the return. The CPA may not inform the IRS of the error without permission of the client. (Note, that this does not create privileged information.)

3. Future Association Judgment: If the error is not corrected, the CPA should decide whether he wishes to continue to be associated with the client or should withdraw. If material, withdrawal is usual. Under such a circumstance, the withdrawal should always be in writing.

4. Do Not Repeat Error: If the decision not to withdraw is made, the error should not be repeated in subsequent tax return years.

G. SRTP 7 Knowledge of Error: Administrative Proceeding

When the CPA is representing a client in an administrative proceeding with respect to a return which contains an error of which the CPA is aware, the CPA should inform the client promptly upon becoming aware of the error. The CPA should recommend the measures to be taken. Such recommendation may be given orally. The CPA is neither obligated to inform the Internal Revenue Service nor is he or she permitted to do so without the client's permission, except where required by law.

The CPA should request the client's agreement to disclose the error to the Internal Revenue Service. Lacking such agreement, the CPA should consider whether to withdraw from representing the client in the administrative proceeding and whether to continue a professional relationship with the client.

This Rule applies when a CPA is representing a client in a tax audit proceeding. If a substantial liability for understatement exists in the return, and the CPA knows of it, he must request the client's permission to disclose it to the IRS. If the client does not agree, the CPA should withdraw from the engagement without violating the confidentiality between the CPA and the client. The AICPA position in this Statement does not create a professional privilege.

H. SRTP 8 Advice to Clients

In providing tax advice to a client, the CPA must use judgment to assure that the advice reflects professional competence and appropriately serves the client's needs. The CPA is not required to follow a standard format or guidelines in communicating written or oral advice to a client.

Tax advice to clients should be delivered in written form, both for good business practice and in order to assure that there are no misunderstandings regarding the nature of the advice given. The advice should generally state all major assumptions, cite relevant authorities, and include a general statement that changes in circumstances may change the advice given. An opinion letter covering the tax consequences of an investment must reach an overall conclusion whether in the aggregate the tax benefits are more likely than not to be realized.

I. Interpretation 1-1 Realistic Possibility Standard

A CPA should have a good-faith belief that the (tax return) position (being recommended) has a realistic possibility of being sustained (administratively or judicially) on its merits if challenged.

1. Disclosure If Not Frivolous: If a position does not meet the AICPA good-faith standard it must be disclosed on the tax return. In no event may a CPA advance a "frivolous" position in bad-faith. The CPA should always advise the client if it is reasonably possible the IRS may impose penalties.

2. IRS Standard: The AICPA's realistic possibility support standard is less than "more likely than not" but more than a "reasonable basis". While the AICPA believes this standard cannot be expressed in terms of percentage odds, the IRS would impose a 1 in 3 chance of success (Reg. 1.6694-2(b)). The AICPA would also allow a wider range of source of permissible literary authority than the IRS. The CPA should consider the weight of the supporting authority by evaluating its persuasiveness, relevance and source.

3. New Statute: A position contrary to a new statute which is clear and unambiguous is frivolous and may not be advanced. If there is support in the legislative committee reports, IRS Notices, or applicable court opinion, the CPA may take such a contrary position. A CPA may rely upon a tax attorney's opinion letter unless, on its face, the opinion appears unreasonable, unsubstantiated, or unwarranted.

II.  IRS PUBLICATION 230

    Publication 230 governs the practice of Attorneys, Certified Public Accountants, Enrolled Agents, and Enrolled Actuaries before the Internal Revenue Service. It specifies that a tax preparer includes a CPA who directly or indirectly receives compensation to prepare all or any substantial part of a tax return or a claim for refund. Doing a return for an audit client for no extra charge may qualify. The employer must retain for 3 years and make available to the IRS a report listing all preparers, their identification numbers and place of work.

    A.  Basic Responsibilities

    IRC 6695 specifies that a preparer must sign the return and enter his identifying number. He must also furnish the taxpayer a copy. IRC 6107 requires a preparer to retain a copy of the return for three years. A penalty of $50 applies to each omission, but is limited to a total of $25,000 per year.

    B.  Due Diligence

    A preparer must exercise "due diligence." The preparer is not required to independently verify a taxpayer's information, but must make reasonable inquiries if such information appears to be incorrect or incomplete. It is prudent to keep a copy of all the client's information going into the return. The AICPA recommends reviewing prior year returns to ascertain the reasonableness of the client provided information on the current return. IRS Procedures would allow an agent to accept estimates (in lieu of actual numbers) if generally accepted and the obtaining of exact data is impracticable.

    C.  Client's Omission

    Publication 230, Section 10.21, specifies that a preparer gaining knowledge of a client's omission shall advise the client promptly in writing of the fact of such noncompliance, error or omission. There is no duty to file an amended return, but practitioners should consider withdrawing to avoid being associated with the fraud.

III. COMMON PREPARER PENALTIES

Preparer penalties are almost always the responsibility of the CPA. In addition, a plaintiff's attorney will argue the preparer penalties are conclusive evidence of tax malpractice and thus liability to the client.

A. Negligence Penalty

1. Standard Applied: Negligence includes the disregard of the law or a misapplication of the Revenue Code or regulations. A penalty of $250 now applies if the preparer takes a position for which there is not a "realistic possibility" of being sustained on the merits. This is intended to be a higher standard than the previous negligence standard of "reasonable support".

2. Safe Harbor: Regulation 1.6694-2(b) provides a safe harbor for applying the "realistic possibility" standard. The IRS deems this standard to be met if a reasonable and well-informed analysis by a person knowledgeable in the tax law would lead such a person to conclude that the position has a 1 in 3, or greater, likelihood of being sustained on its merits.

B. Willful Understatement

IRC 6694 dictates that a willful attempt to understate tax liability or endorse another's refund check will produce a $1,000 preparer penalty. "Willful" means the understatement is intentional, conscious and voluntary.

C. Reasonable Basis

To avoid the penalty, the preparer must demonstrate a reasonable support for the position; it must be arguable but does not have to rise to the level of more likely than not. A tax attorney's opinion letter may qualify.

D. Disclosure Abatement

This penalty may be abated if the preparer makes disclosure on the return of the position supporting the understatement.

IV. AIDING AND ABETTING

The IRS now intends to curtail professional advisors assisting or participating in organized tax-related crimes including abusive tax shelter promotion.

A. Statutory Penalties

IRC 6701 added "aiding and abetting" penalties of $1,000 per individual return; this is raised to $10,000 for a partnership or corporate return. Asset overvaluation will produce a penalty of the greater of $1,000 or 30 percent of the shelter's gross income.

B. Scope Expansion

The Revenue Reconciliation Act of 1989 specified that aiding and abetting penalties could be asserted against professionals who were associated with documents not arising under the internal revenue laws. This would seem to broaden the definition from strict return preparation; even tax advice in the form of a written tax shelter opinion may now constitute a violation.

C. Tax Shelter Opinions

The IRS has placed restrictions on CPAs who prepare opinion letters covering a tax shelter's benefits. Publication 230, Section 10.33 now requires a practitioner rendering an opinion on a tax shelter to provide a concise overall evaluation whether the material tax benefits in the aggregate are more likely than not to be realized. Non-opinion opinion letters are no longer allowed.

D. Disbarment and Criminal Penalties

IRC 7201 provides that the IRS can enjoin a preparer from practicing. ln addition, IRC 7206 provides for potential criminal felony charges of up to three years imprisonment and $100,000 fine. Publication 230, Section 10.51 extends potential disbarment to disreputable conduct which is defined rather broadly, including giving false information or making an improper attempt to influence a Revenue officer. Section 10.52 specifies this remedy may apply to a willful violation of Treasury regulations.

V. TAX INFORMATION DISCLOSURE

IRC 7216 prohibits a CPA from disclosing tax information without the written consent of the taxpayer. Disclosure pursuant to a court order is excluded, but a mere discovery request or subpoena duces tecum issued by an attorney is not a court order. The wording of the client's consent form is important because the statute specifies that each separate use or disclosure must have an individual consent. A CPA whose client will not consent in writing to the disclosure may be wise to tell the requesting party to obtain a court order. Other information not received in connection with a tax return preparation (such as reporting documents) is not subject to this restriction and can be subpoenaed where relevant to issues raised in litigation.

VI. IRS PRODUCTION OF DOCUMENTS

IRC 7602 provides the IRS may summon either the taxpayer or a third party and may require production of documents or records. IRC 7609 requires notice to the taxpayer within three days of a IRS summons being served on third parties such as taxpayer's bank, accountant or attorney. The taxpayer has twenty days to file a motion to quash. After twenty days, the IRS issues a certificate stating the period has expired and that the third party has no liability for compliance.

Robert v. Chaple, 369 S.E.2d 482 (Ga. App. 1988) held that a CPA's disclosure to the IRS under an informal request violated the IRC 7216 requirement of client's information confidentiality. The prudent position would seem to wait for the IRS certificate unless the client consents in writing.

VII. CLIENT TAX ENGAGEMENT MEMORANDUM

A formal signed agreement with the client is preferable, but if this is not feasible, try a negative tax engagement letter. This letter should include all the CPA firm's tax Policies and Procedures and should be mailed with the annual client's organizer package. See the tax services memorandum information and common ingredients on pages 78-80.

VIII. CLIENT LAWSUIT STATUTE OF LIMITATIONS

The time period within which the client must file suit is more complicated in the tax area than in reporting engagements. The agreement should specify one year. There are three default rules and the CPA should check with local counsel to determine which applies in your state.

A. Work Product Date

Ackerman v. Price Waterhouse, 644 N.E.2d 1009 (N.Y. 1994) held that the client's statute of limitations to sue the CPA is triggered when the taxpayer received the tax return.

B. Final Assessment Date

Other states have held the statute only commences upon the receipt of the final audit assessment since that was the date the legal obligation to pay arose. See International v. Feddersen, 38 Cal. Rptr.2d 150 (Cal. 1995) for an example where there was continuous representation by the CPA in the audit process.

C. "Discovery" Date

Many states have a date of "discovery" rule requiring an analysis of the government audit process. Under the "discovery" rule, the statute is triggered when the taxpayer knew to a reasonable certainty that damages would result from the tax error by the accountant.

IX. COMMON CLIENT TAX CLAIMS

In theory, the tax is the client's responsibility not the preparer's; thus the usual audit deficiency is not recoverable because the client should have paid the higher tax originally. Interest on deficiencies is the cost of borrowing the money which the client enjoyed the use of; see Leendertsen v. Price Waterhouse, 916 P.2d 449 (Wash. App. Div. 1 1996). Timing adjustments have no long-term consequences. As long as the statute is still open for the year in question, a client should be able to file an amended return and claim a refund for a tax advantage forgone. This narrows the theoretical range of viable tax claims to penalties and tax opportunities which are not recoverable.

A. Competency and Due Care

The complexity of the tax law grows every year. Tax practitioners must know and stay current on all of the rules. Do not get in over your head. If you are not familiar with all the subtle tax rules, do not hesitate to consult with someone who is.

B. Elections and Opportunities

Such elections as the 1244 stock, "S" corporation and partnership basis may provide future tax opportunities. Election deadlines should be entered on a calendaring system. For on-going clients there may be a duty to structure transactions to minimize the tax consequences. Where attorneys and accountants work together on a new business venture or transaction involving tax matters, there must be a clear understanding of who is responsible for what.

C. Alternative Minimum Tax

The Alternative Minimum Tax (AMT) attempts to ensure that all income is subject to some tax. Accountants that create income minimizing techniques must consider this tax. Clients who think they will pay no tax may expect you to pay the AMT.

D. Estate Tax Matters

Accountants that do fiduciary, gift and estate tax work must really understand all the applicable rules in detail. On a damage/fee ratio, it is one of the highest risk areas.

1. Aggravating Conditions: The high rates (55% for estates over $3 million) and aggressive IRS gift and estate auditors make the potential damages more significant than in most income tax work. The IRS establishes breach of the preparer's duty. In addition, the estate beneficiaries may be less forgiving than the decedent about any tax mistakes. The nine month form 706 deadline, 5% per month penalty, alternative valuation date, election to value a closely-held business, disclaimer possibilities, tax allocation among beneficiary groups, QTIP election, and other post-mortem planning opportunities lost are all potential areas of liability.

2. Split Responsibility: Trouble may result if this responsibility is split between an attorney and an accountant. Because attorneys handle the legal aspects of a probate, the engagement letter must contain a clear understanding of who is responsible for what.

E. Informal Opinion on Complex Tax Transactions

Clients may expect you to give an on-the-spot telephone opinion on whether a like-kind exchange or corporate reorganization will qualify for non-recognition treatment. This is dangerous because you usually do not have all the facts and do not do formal research to support the advice. If the tax matter involves large dollars, the client should pay a reasonable fee for your input and participation. Do it right with proper research and a written opinion letter. There is a very good reason the IRS has established a pre-transaction ruling procedure for major transactions. Use a computerized projection to ensure your first impression was accurate.

X. COLLECTION MATTERS AND OFFERS IN COMPROMISE

This author has found that insolvent clients may have unrealistic expectations about what value a CPA may add in the collection process. In addition, you are competing with the IRS for payment of your fee. The necessary IRS disclosure required to present an offer-in-compromise involves itemizing the taxpayer's assets and income sources on form 656 (and perhaps 433-A or 433-B). Based upon this disclosure, the IRS may subsequently levy or garnish and the client may blame the CPA. Be careful and fully inform the client of all the possible collection risks in the engagement letter. The engagement letter should contain your fee payment terms and often will request a substantial retainer.

XI. AGGRESSIVE TAX POSITIONS

Often clients will insist a CPA take an aggressive position on a return. An example is characterizing a capital asset transaction as qualifying for non-recognition treatment where there is considerable tax dollars at stake.

A. Risk Disclosure

All the material risks should be disclosed to the client in writing; they and not the CPA should always make the final decision to proceed. The higher the dollars involved, the greater the necessity of a thorough analysis that the client approves.

B. Client Assumption of Liability

The client must realize that it is their tax dollars at risk and that they (and not the preparer) save if an aggressive position is successful. Prudence suggests that the client assume all liability for any negligence and related penalties which may result. Absent this type of protection, the client may use the IRS assertion of civil preparer penalties as a basis for a civil suit.

XII. ACCOUNTING - TAX LIABILITY RELATIONSHIP

There is a possible liability cross-over area between tax compliance work and financial statement reporting.

A. Only Financial Statement

A CPA may prepare a proprietor's Schedule C or annual corporate tax return and create and post year-end adjusting entries to the general ledger and trial balance. Unless there is an engagement letter, it is difficult to defend against the claim that the examination of the records should not be considered a reporting engagement. This is especially true if there is no business financial statement prepared other than the tax return and the CPA knows the income statement will be submitted to a third party. SRTP 3 does not require a CPA to verify the client's information; in comparison GAAP suggests some investigation is prudent in all reporting engagements.

B. Case Authority

See Griffith Motors, Inc. v. Parker, 633 S.W.2d 319 (Tenn. App. 1982) in which the CPA was held liable for failing to detect a check-kiting scheme. The CPA's defense was that it was only a tax preparation engagement and not a reporting engagement. There was no other financial statement prepared and no engagement letter clarifying the nature and limitations of the work.

Rigos Professional Education Programs and those insurance carriers and professional associations that sponsor this web-site, related seminars, material and protective forms do not intend any part of this information to create professional standards or constitute formal legal advice. Every case is different and these general loss control principles may not control or even apply to a particular situation. State and national laws may also vary between jurisdictions. Accountants should contact their personal attorney or insurance claim agent for professional advice regarding the application of these principles to the specific facts of each case.

By downloading materials from Rigos Professional Education Programs (RPEP), down loader hereby agrees to be personally liable and to fully indemnify RPEP for any and all damages directly, indirectly and/or consequentially resulting down loader's attempted or actual downloading or other duplication of materials from RPEP, alone or with, or under the authority of, any other person(s), including, without limitation, any governmental agency(ies), fines, and attorney's fees.