When a CPA discovers a taxpayer’s past noncompliance, there are both ethical and practical questions to answer. The last thing a CPA should want to do in this situation is turn a manageable issue into a serious problem. Although these issues have many nuances, there are some basic principles to follow in deciding how to address past noncompliance by clients and how to handle the filing of tax returns that are currently due.
What Ethical Standards Apply to CPAs When a Client Has Been Noncompliant?
There is no obligation for a taxpayer to file an amended tax return; there is such no requirement in the Internal Revenue Code (IRC), Treasury Regulations, court decisions, or other guidance. It may be to one’s advantage, however, to file an amended return to correct past noncompliance. Some methods for correcting non-compliance are discussed briefly below.
Although the taxpayer may not have a duty to file an amended return, the CPA may have a duty to recommend that he do so. This duty is governed by Treasury Department Circular 230, Regulations Governing Practice before the Internal Revenue Service, section 10.21, and AICPA Statement on Standards for Tax Services (SSTS) 6, Knowledge of Error: Return Preparation and Administrative Proceedings. Circular 230, section 10.21 provides that “a practitioner who … knows that the client has not complied with the revenue laws of the United States or has made an error in or omission from any return … must advise the client promptly of the fact of such noncompliance, error, or omission,” and “must advise the client of the consequences as provided under the Code and regulations of such noncompliance, error, or omission.”
Likewise, SSTS 6 requires that a CPA inform the taxpayer promptly upon becoming aware of an error in a previously filed return, an error in a return that is the subject of an administrative proceeding, or a failure to file a required return; advise the taxpayer of the potential consequences of the error; and recommend the corrective measures to be taken. Therefore, the AICPA’s standards of conduct require that the CPA actually recommend that the taxpayer amend her return, while Circular 230 does not go that far.
SSTS 6 further states that if a taxpayer asks a CPA to prepare the current year’s return while the taxpayer 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 discontinue the professional relationship. Similarly, if a CPA is representing a taxpayer in an administrative proceeding with respect to a return that contains an error the CPA is aware of, the CPA should request the taxpayer’s agreement to disclose the error to the taxing authority. Lacking such agreement, the CPA should consider whether to withdraw from representing the taxpayer in the administrative proceeding and whether to continue the professional relationship with the taxpayer. Of course, a CPA is not allowed to inform the taxing authority without the taxpayer’s permission, except when required by law.
The Explanation to SSTS 6 expands upon the question of withdrawal from the engagement and explains that a CPA may opt to do so because a “taxpayer’s decision not to file an amended return or otherwise correct an error may predict future behavior that might require termination of the relationship” (para. 8). Accordingly, even though the language of SSTS 6 suggests an obligation to withdraw, it is within the CPA’s discretion whether to do so or not. Furthermore, the Explanation also states that:
Whether an error has no more than an insignificant effect on the taxpayer’s tax liability is left to the professional judgment of the member based on all the facts and circumstances known to the member. In judging whether an erroneous method of accounting has more than an insignificant effect, a member should consider the method’s cumulative effect, as well as its effect on the current year’s tax return or the tax return that is the subject of the administrative proceeding (para. 13).
Thus, if a CPA believes the error on the prior return is not material—that is, it has no more than an “insignificant effect on the taxpayer’s tax liability”—the CPA is not required to advise the client to correct the past noncompliance.
What Are Some Considerations for Advising a Client on Filing an Amended Return?
Aside from ethical considerations, recommending the filing of an amended return might also be to the client’s benefit. Of particular interest in this respect is a qualified amended return. A qualified amended return is an amended return that corrects an error in a previously filed return prior to the taxpayer being contacted by the IRS regarding the return [Treasury Regulations section 1.6664-2(c)(3)]. The effect of a qualified amended return is to eliminate the accuracy penalty under IRC section 6662 on the amount shown as additional tax on the qualified amended return [Treasury Regulations section 1.6664-2(c)(2)].
A qualified amended return, however, does not prevent the IRS from assessing fraud penalties [Treasury Regulations section 1.6664-2(c)(2)]. In Badaracco v. Comm’r [464 U.S. 386 (1984)], the Supreme Court considered the impact of filing an amended return correcting a previously filed fraudulent return, specifically on the application of the unlimited statute of limitations for assessment of tax in the case of fraud under IRC section 6501(c). The court ruled that the statute of limitations is not reduced: “In short, once a fraudulent return has been filed, the case remains one ‘of a false or fraudulent return,’ regardless of the taxpayer’s later revised conduct, for purposes of criminal prosecution and civil fraud liability …. It likewise should remain such a case for purposes of the unlimited assessment period specified by section 6501(c)(1)” (Badaracco at 394). Accordingly, the filing of an amended return does not cure a prior fraudulent return; the IRS has an unlimited civil statute of limitations to assess taxes and fraud penalties, and the taxpayer can be criminally prosecuted.
A taxpayer who has filed a fraudulent return may avoid criminal prosecution and be able to reduce her penalties by making a voluntary disclosure. The Internal Revenue Manual, para. 18.104.22.168, “Voluntary Disclosure Practice,” describes the IRS’s voluntary disclosure policies and procedures and states that taxpayers can voluntarily disclose both domestic and offshore tax noncompliance. Help is available at https://www.irs.gov/uac/How-to-Make-a-Domestic-Voluntary-Disclosure and https://www.irs.gov/uac/2012-Offshore-Voluntary-Disclosure-Program.
What About Returns That Are Currently Due?
A CPA or other tax professional can never advise a client to not file a return that is required to be filed and is currently due or to delay a filing. A CPA may, of course, advise on whether the client has a filing obligation in the first place, for example, whether a client is required to file a Form 8931. When a taxpayer is required to file a return, however, a CPA cannot advise the taxpayer to not file or to delay filing. It is important to keep in mind that willful failure to file is a crime—either a misdemeanor under IRC section 7203 or felony tax evasion under section 7201, depending on the circumstances. A CPA or other tax professional who encourages a client not to file could be charged with one of those offenses, or with aiding and abetting the taxpayer.
The question then arises as to how a CPA should advise a client whose tax return for the current year may result in self-incrimination. For example, if a taxpayer is under criminal investigation for not reporting foreign bank accounts, and those accounts would have to be disclosed on an accurate Form 1040 and FBAR, the taxpayer may be incriminating himself by filing the returns. In this situation, however, a CPA cannot advise the client to not file the return. The Supreme Court has long held that the Fifth Amendment privilege against compulsory self-incrimination is not a defense to prosecution for failing to file [Sullivan v. U.S., 274 U.S. 259 (1927)]. A taxpayer may, however, refuse to answer specific questions or disclose specific information if that disclosure would be incriminating [Sullivan at 263; see also Garner v. U.S., 424 U.S. 648, 650 (1976)]. To assert a valid Fifth Amendment privilege against self-incrimination, a taxpayer must claim the privilege on the return as an objection to a specific question [Garner at 665; Sullivan at 263-264; Heligman v. U.S., 407 F.2d 448, 450-451 (8th Cir. 1969)].
When Should an Attorney Be Consulted?
SSTS 6 states that “if a member believes that a taxpayer may face possible exposure to allegations of fraud or other criminal misconduct, the member should advise the taxpayer to consult with an attorney before the taxpayer takes any action” (Explanation, para. 11). An attorney may be able to provide useful advice regarding the best method to correct noncompliance and whether and how to file a Fifth Amendment return. When it comes to potential criminal prosecution, it is important to remember that conversations with a CPA will not be privileged.
IRC section 7525(a) extends the common law attorney-client privilege to “federally authorized tax practitioners,” which of course includes CPAs. Section 7525, however, only applies in noncriminal tax proceedings before the IRS and in the federal courts when the IRS is a party. Therefore, the privilege does not protect against disclosure of communications in criminal investigations or proceedings or against disclosure of information to any regulatory body other than the IRS. Moreover, the IRS’s position is that the IRC section 7525 privilege will not apply in a criminal proceeding even if the communication originated in the context of a civil matter or proceeding (Litigation Bulletin 200017039, https://www.irs.gov/pub/irs-ccbs/glb473.pdf).
The IRS takes all cases of noncompliance very seriously. CPAs should be aware of how to guide their corporate and individual clients through the above processes in the event that they are or become noncompliant, whether through accident or intent.