Tax Preparers Beware! Uncle Sam is Watching Ever More Closely

[note: Added 01/28/08 – link to IRS Revenue Procedure 2008-14 covering “Adequate disclosure for Statements on Tax Return” for purposes of reducing an understatement of income tax under section 6662(d) and for purposes of avoiding the section 6694(a) preparer penalty.]

Report from the IRS Practitioner Liaison meeting in Los Angeles, January 17, 2008 – at the Los Angeles Federal Courthouse

    Although this is mostly for the benefit of tax professionals, it’s in your interest to read today’s IRS News too. You’re going to learn what IRS is concerned about when it comes to the people who prepare your tax returns, and what kind of advice not to rely on.

    You’re going to get something to think about when it comes to conflicts of interest – not just conflicts between you and your about-to-be-ex spouse, or former partner. Your own tax preparer representing you at audit or collections may have a conflict.
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    They may need to protect themselves at your expense. Learn why.

    And you’re going to learn why you NEVER want to sign an audit report that assesses you additional taxes, especially when it assesses you under-reporting penalties, without first showing that audit report to your original preparer.

Aside: Despite the ominous title, we had a great deal of fun at the meeting. So let me take the liberty of inviting you to the next one. If your organization or society or chapter is not already represented, please get hold of Sharon Sanders in the Los Angeles office, and get added to the invitation list. And if your organization is represented, why don’t you see if you can sit in for your usual representative? Aside from seeing IRS in a much less hostile light, you’ll make some excellent contacts – and be involved in the process of improving the tax system for us all. This is one of the very best ways for one person to make an impact.

Jordan Musen, SB/SE Area Counsel, covered changes to Circular 230. Sherri Wilder, SB/SE Area Counsel, covered J-Date and preparer penalities.

For those of you not familiar with Circ 230, it is the small, but growing, white pamphlet that contains the rules of conduct for CPAs, EAs, Attorneys, and Enrolled Actuaries. You’d have to be living under a rock not to be aware of the many additions to Circ 230 last year. The newest edition is dated Sept 26, 2007 – .

Jordan made us aware of some of the highlights of the changes that will be important for us to implement.

Conflicts of interest – Conflicts can arise between couples, partners, shareholders, members of LLCs, employees of a client business, etc. Circ 230 demands that you do something common-sensical. If you want to work with both or all of them, or they insist that you do, you must get a written release from BOTH (or all) parties the instant you realize that a conflict exists.

Once you learn that a conflict exists, you must stop work and prepare the written release for everyone to sign. This will relate to preparing tax returns, giving advice or representing them in audit or collections matters. Aside from the fact that this is now law, this really is great advice, designed to protect you from litigation.

For instance, when you are dealing with a married couple about to embark on a divorce, working with both of them is a conflict of interest. IRS feels that you cannot fairly look after the interests of both parties. Perhaps you can – but beware of nasty divorces. You will become the scapegoat in all financial situations if you remain in the middle, working with both. You’ll become of the victim of the “Mother loves you best” syndrome, where one spouse is apt to claim that you gave preferential treatment to the other.

Sometimes you know that you’re just better off, gently referring each of them to other tax professionals and staying out of the middle. Sometimes you know that you can do a better job for both of them, if you can coordinate their respective tax issues with each other. There’s a lot you can do to maximize the tax benefits of dependents, credits and deductions if the couple can work together.

Incidentally, another conflict that may arise is between you and your client. When IRS is looking at major errors or discrepancies in a tax return, audit information or financial report in collections situations – they will also be looking at preparer penalties. You may be facing a situation where it’s your neck or theirs. Time to get a conflict of interest letter signed – or remove yourself from the engagement, to represent just yourself.

Contingent Fees – A contingent fee is where the fee is based on a percentage of the refund or taxes saved. Or when we offer to reduce or waive our fee if we cannot get the intended result. Circ 230 spells out the very few places where we may charge them. Never for preparing the initial tax return for any years. And never for giving written advice, or in connection with any qualified plans.
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These rules are effective for all fee agreements dated after March 26, 2008. We may charge them only in the following instances (read Sec 10.27):

  • 1) Representing taxpayers at audit
    • a) of an original return
    • b) or of an amended return or claim for refund, where the amended return or claim for refund or credit was filed within 120 days of the taxpayer receiving a written notice of the examination of, or a written challenge to the original tax return.
  • 2) In connection with a claim for credit or refund filed solely in connection with the determination of statutory interest or penalties assessed by the Internal Revenue Service.
  • 3) In connection with any judicial proceeding arising under the Internal Revenue Code.

When a practitioner is suspended from practice before IRS, that means we may not provide written advice, either.

Which led to an overview of Sanctions by the Office of Professional Responsibility (OPR).
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For those who don’t know, this is the group at IRS that can pull your ticket and put you out of business – if you’re a Circ 230 practitioner. At the present, the vast general population of tax professionals in 47 states (not including Orgeon California and New Jersey) are not under the jurisdiction of IRS’s OPR, or of any state authority. (There is a bill pending in Congress that we hope will change that someday.)

Sanctions – can include penalties, private reprimands, public censure, suspension or disbarment. Penalties can be as high as $5,000 or as much as 50% of all the fees you receive, or expect to receive from the sanctionable advice given.

Who may be assessed penalties?
Some preparer penalties apply to non-enrolled preparers.
Sometimes, the preparer’s firm or employer may also be penalized, when they knew, or should have known about the activities.

Since we had heard that the term “return preparers” has been expanded to include non-signers of the return, that sent chills down our backs. Who are these non-signers? Do they include volunteers, like VITA workers and AARP Tax-Aide workers? No.
They include partners of the firm where the return was prepared, they include those who provided written advice, on the basis of which the positions in the return were taken. They include preparers who get paid under the table, but don’t actually sign the return.

Your investigation may result in a formal slap on the wrist, in the form of a private letter. It may result in a public letter with your name appearing on the IRS list of sanctioned practitioners. A taxpayer can call OPR at any time to learn if you are on the list. The list will not say why you were sanctioned, in routine matters.

You can be suspended, which will prevent you from working for 5 years. After which you can re-apply. Or you can be disbarred. Naturally, it can get worse. You can face criminal prosecution – in which case, you’re no longer operating within the area of OPR, but IRS’s Criminal Investigation Division.

At what point will your name be revealed to the public in a press release? When your indicted in court, or sentenced by the court. Any earlier, and IRS is releasing privileged information.

Sanctions and penalties can come about in a number of ways – someone (a client or other tax professional, or IRS staff, or…) can file a complaint against you, or a penalty levied during an audit or collections matter may bring you to the attention of OPR.

We discussed a recent case brought up a CSEA dinner meeting with Sherri Wilder. The CPA had been involved in an audit. Preparer penalties were proposed of $1,000. The CPA negotiated them down to a lesser offense, and lower fee, of $250. He felt that paying the $250 would be cheaper than expending his time to defend himself. As a result, an OPR investigation was opened. His CPA society investigated him and proposed sanctions, and his malpractice insurance premiums went up.

I asked if this was going to be the typical pattern after an audit. Will all preparers who face any preparer penalties whatsoever end up like this?

Sherri replied that the case must have more to it than what we were told. OPR will not waste their time with full-blown investigations for minor infractions. They simply don’t have the manpower. However, when they see a pattern of behavior, or a pattern appearing in tax returns prepared by the same person, they will launch an investigation. She believes that is most likely what happened in this case.

Jordan explained that OPR gets about 500-600 referrals of bad conduct a year. About half are eliminated quickly as irrelevant, or not under the jurisdiction of OPR (like non enrolled preparers).
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Of the other 300 or so, most are settled, one way or the other. About 40 cases, less than 10% go on to an appeals process. Only about 4-6 (1%) don’t settle and go before an Administrative judge or District Court. IRS has NEVER lost one of these case. (Note: Since OPR only prosecutes the most egregious cases, and settles the rest, when they prosecute, they know they have a solid case.)

We got into some what-if discussions about audits.

What if a tax professional represents a client on a tax return s/he didn’t prepare and preparer penalties are assessed – will the penalties be assessed against the person at the audit or the original preparer? Against the preparer.

What if you’re the original preparer of that return and you KNOW that you took the right position, and would have gotten a no-change audit if only you had been able to represent the tax return yourself?
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Will you have an opportunity to vindicate yourself? Yes. You will get a letter proposing the penalty and will have an opportunity to respond before it is assessed.

Suppose you do that, and you win your case, and you prove that the position was correct and that no taxes should have been assessed on that matter in the first place? Can the taxpayer file a claim for refund to correct the audit result? No. Once the taxpayer signs the consent to the audit assessment, they’re locked in. So, this is a very good incentive for a taxpayer with poor audit results to refrain from signing the closing agreement and to review the audit report with the original preparer before signing – especially when any taxpayer penalties are assessed.

Sherri told us that the scope of returns that are included in the purview of preparer penalties has increased. It only used to apply to tax returns. Now it applies to all returns, filings, etc.

She discussed the realistic possibility standard (Sec 10.34) – that means you have a more than one in three chance of the position you’ve taken being sustained based on the facts, and your citations. The “more likely than not” standard (Sec 10.35) for written advice requires a better than 50% chance of being sustained.

When you take a position that you think may be in any doubt be sure to disclose the situation with a written statement accompanying the tax return. You can use Form 8275 Disclosure Statement, to spell out your treatment based on existing law or procedure. Or you may use Form 8275R when you are taking a position contrary to Treasury regulations – and you have a good reason for it.

Do not rely on written statements or advice from promoters. Those are attorneys or professionals who issue an opinion to help sell a tax savings vehicle of any kind. Demand to see the cases, or code sections, or regulations or rulings, or whatever, on which their opinion is based. READ THEM FOR YOURSELF. They may, in fact, contradict what the promoter is supporting. If you do not have time to do your due diligence, pass on that tax return.

IRS’s position is that you can also use common sense. Relying on advice from other professionals simply won’t fly if you should have known better. Think disclosure!

Sherri answered a question about e-filing. When it comes to cases of fact (based on using estimated numbers, incomplete information, etc.) you may attach a text statement or worksheet to an e-filed return. You are not required to file a paper return. Most professional tax software allows for text statements and numerical lists that will print with the return or are suppressed, to be used for internal notes only. Where disclosure is required, press the PRINT WITH RETURN box. Include enough information that someone reading the return can determine the facts and circumstances – and can know if they need to get clarification.

Incidentally, James Nelson talked to us about the Chief Counsel’s Attorney Recruitment Program. Read my notes about it in last Friday’s Ask TaxMama.

There was more. But these are the highlights. Anyone who was there is certainly welcome to add their notes. Just click on the Comments link below.

And be sure to look at the links to forms and Pubs in the Resource Box below, too.

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