The AICPA’s Statements on Standards for Tax Services (SSTS) are now an authoritative part of the Code of Professional Conduct. As such, they are now applicable to all of a CPA’s tax planning and tax return preparation practice and should be regarded as “best practices standards” for tax preparers. It is worth noting that the 2015 AICPA ethics recodification expressly requires all CPAs to file their own individual tax returns. Professional discipline for tax offenses is possible.
Most state boards include rules on tax return preparation and the furnishing of advice on tax matters in the category of the “practice of public accountancy.” Tax claims are now the most frequent malpractice claim asserted against CPAs. Adhering to the best practices in the SSTS is a sensible safeguard against the risk of malpractice claims for tax preparers.
There are seven current AICPA statements, SSTS 1 through 7. The provisions for each are discussed below, as well as the related Interpretation 1-1.
SSTS 1: Tax Return Positions Contrary to IRS
The CPA’s role is as an advocate for the client, with a duty to arrive at the legal minimum tax possible in accordance with the applicable standards. The CPA must, however, have a “good faith” belief that a controversial tax position has a “realistic possibility” of prevailing if questioned under audit. CPAs may recommend a tax position that has a “reasonable basis” of being sustained with adequate disclosure of the position. They should advise taxpayers as to the potential penalties of a position taken and any opportunities to avoid such penalties. CPAs should not recommend tax positions that exploit the audit selection process or serve as an arguing position solely to obtain negotiating leverage. The client should make the ultimate decision.
SSTS 2: Answers to Questions on Returns
CPAs should secure from the taxpayer all the information needed to complete the tax return before signing the return. The basis for omitting an answer to tax return questions should be limited to the following situations:
- The information is not readily available, and any exact amount variance is not significant in terms of determining taxable income or loss;
- Genuine uncertainty exists regarding the meaning of the question; or
- The answer is too voluminous.
Where the answer to a question on a tax form is omitted, CPAs should consider whether the return is deemed incomplete or likely to result in penalty. One approach is to provide a brief explanation of the omission in a footnote.
SSTS 3: Procedural Aspects of Preparing Returns
SSTS 3 addresses whether it is necessary for CPAs preparing or signing a tax return to audit the information furnished by the taxpayer or third parties. The answer is generally no, as long as two conditions are met:
- The information appears reasonable on its face; and
- The information does not appear to be inconsistent with prior years’ tax returns. CPAs should urge a client to provide supporting data where appropriate.
CPAs may also accept the characterization of income and expense items on third-party source documents such as W2s, 1099s, and K1s. This would include capital gain versus ordinary income, the taxation of retirement plan distributions, and pass-through entities. It is thus not usually necessary to audit or otherwise inquire into the details of a taxpayer’s source documents. CPAs should make reasonable inquiries where they believe the information presented is incorrect or incomplete.
SSTS 4: Use of Estimates
SSTS 4 allows the use of estimates in lieu of actual amounts, if the following conditions are met:
- Such use is generally acceptable among CPAs;
- It is not practical to obtain exact data; and
- The estimate appears reasonable under the circumstances.
The taxpayer’s estimates should be presented in a way that does not imply more accuracy than actually exists.
SSTS 5: Departure from a Position Previously Concluded in an Administrative Proceeding or Court Decision
Tax positions should be based on the facts and law when the return is prepared, and taxing authorities tend to act consistently with prior results. It may, however, be possible to distinguish the current situation from the previous administrative proceeding or court decision. A significant factual difference may qualify, as may more substantial documentation. In addition, more recent decisions, rulings, or other authoritative guidance may develop the tax law such that a different court decision may result. Under such circumstances, it would be prudent for a CPA to get a tax attorney’s opinion letter to support the position so that the facts or law can be distinguished.
SSTS 6: Knowledge of Error: Prior Return Preparation and Administrative Proceedings
Upon becoming aware of an error, CPAs should inform the taxpayer and recommend that corrective action be taken. SSTS 6 provides for the following seven procedural steps:
- The client should be notified of the material error and be informed as to the consequences of noncompliance (e.g., penalties imposed under audit) and the steps necessary to correct it. This usually means amending a prior return or filing an original return.
- A CPA must request a client’s permission to disclose the error to the taxing authority. If the client does not agree, the CPA should withdraw from the engagement without violating their confidentiality. The withdrawal is best if written. This does not create a professional privilege.
- Taxpayers must decide whether or not to correct their own returns. CPAs may not inform the taxing authority of the error without permission of the client.
- If an error is not corrected, a CPA should decide whether she wishes to continue a professional or employment relationship with the client or withdraw from the representation. If the amounts at play are material, withdrawal is usually advised. Under such a circumstance, the withdrawal should usually be in writing.
- If the decision not to withdraw is made, the error should not be repeated in subsequent tax return years.
- Failure to answer a taxing authority agent’s questions fully and accurately about unreported income may draw aiding and abetting preparer penalties. CPAs should take care not to be pulled into clients’ tax controversies.
- 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). A tax attorney may be able to provide useful advice regarding the best method and procedure 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.
SSTS 7: Form and Content of Advice to Clients
Tax advice varies widely. It should be delivered in written form, both for good business practice and to ensure that there are no misunderstandings. 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. Written advice covering the tax consequences of an investment must reach an overall conclusion as to whether the substantial tax benefits are more likely than not to be realized.
Most states follow Restatement of Torts (2d. Ed., section 552) in imposing potential third-party liability upon a CPA in the typical public reporting engagement. When a CPA gives personal tax advice, he acts in a private capacity, and the fiduciary duty applies only to clients and not third parties [see Seldon v. Burnett, 754 P.2d 256 (S. Ct. Alaska, 1988)].
In comparison, some states have expanded the privity rule to family members who are damaged by the active negligence or omission of the CPA. In Linck v. Sommerfield, CPA [667 P. 2d 171 (S. Ct. Alaska 1983)], the court held that the family CPA was potentially liable to children and grandchildren for failure to advise a widow that she could save substantial tax by disclaiming some portion of her husband’s estate. Thomas v. Cleary [768 P.2d 1090 (S. Ct. Alaska 1989)] held that a tax malpractice case against a CPA requires that there be an actual IRS assessment so that there are real damages. Expert testimony about what taxes may possibly be asserted is insufficient.
Interpretation 1-1: Realistic Possibility Standard
CPAs must have good faith belief that the position taken on a tax return has a realistic possibility of being sustained on its merits. Otherwise, this must be disclosed on the return. In no event may a CPA advance a frivolous position made in bad faith. CPAs should always advise a client if it is reasonably possible that the IRS may impose penalties on an aggressive position.
While the AICPA believes that the “not frivolous” standard cannot be expressed in terms of a percentage, the IRS imposes a 40% chance of success on all preparers of all or a substantial portion of any federal tax return. For tax shelters and listed transactions, the minimum threshold is raised to a “more likely than not” standard, equivalent to 50% [see Circular 230 section 10.34 and Internal Revenue Code (IRC) section 1.6694]. The AICPA also allows a wider range of permissible literary authority than the IRS. CPAs should consider the weight of the supporting authority by evaluating its persuasiveness, relevance, and source.
CPAs must have good faith belief that the position taken on a tax return has a realistic possibility of being sustained on its merits.
A position contrary to a new statute that is clear and unambiguous is deemed frivolous and may not be advanced by a CPA. Only if there is substantial support in the legislative committee reports, IRS Notices, or applicable court opinions may a CPA may take such a contrary position. A CPA may usually rely upon a tax attorney’s opinion letter unless, on its face, the opinion appears unreasonable, unsubstantiated, or unwarranted.
Written tax advice for a client should include a statement that the opinion letter may not be effective at avoiding possible penalties imposed in an audit. This includes those opinions where the tax-motivated transaction is intended to avoid tax or is subject to a required condition of confidentiality [Klamath v. United States, 568 F.3d 537 (5th Cir. 2009)].
The IRS continues to indict and criminally prosecute CPAs who are too aggressive in promoting abusive tax schemes. Preparers may also be prosecuted. Since 2001, more than 300 injunctions have been issued against promoters and CPAs who prepare returns containing such positions.
IRS Circular 230
Circular 230, effective June 9, 2014, governs the practice of CPAs, attorneys, enrolled agents, and enrolled actuaries before the Internal Revenue Service. It specifies that “tax practitioner” includes an attorney or CPA who prepares and files documents or renders written advice on all or any substantial part of a tax return or a claim for refund. Doing a tax return for an audit client for no extra charge may qualify.
CPA firms should have adequate control procedures in place. Tax department control supervision must be under the authority and responsibility of a particular named person or the IRS will designate same. All staff members must file their own personal returns on a timely basis. Tax records must be retained for at least three years, and a report listing all preparers, their identification numbers, and place of work must be made available to the IRS upon request.
Basic responsibilities.
IRC section 6695 specifies that a preparer must sign the return and enter his identifying number. He must also furnish the taxpayer a copy of the return, but not necessarily all of his research or other data. IRC section 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 $25,000 per year total.
Due diligence.
A 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. The 2016 Form 8867 puts new responsibilities on a preparer of returns containing refundable credits; it is therefore prudent to keep a copy of all the client’s information. Prior years’ returns should be reviewed to ascertain the reasonableness of client-provided information on the current return. IRS procedures allow an accountant to accept estimates (in lieu of actual numbers) if they are generally accepted and if obtaining exact data is impracticable.
Client’s omission.
Circular 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. CPAs are not obliged to file an amended return unless the client agrees, but they should consider withdrawing to avoid being associated with any significant fraud.
Spousal conflict of interest.
Representing two clients in a tax matter whose interests are adverse requires both clients to waive the conflict by giving their informed consent in writing (Circular 230 section 10.29). Depending on the circumstances, merely confirming an oral conflict waiver in writing may be insufficient for civil liability purposes. Such directly adverse conflicts as the innocent spouse provision, carry-forward basis allocations, and prior open years’ tax responsibility may make representing both spouses in a divorce difficult or impossible because their interests are directly adverse. As another example, a corporate tax policy may conflict with the best interests of the shareholder client.
Common Preparer Penalties
Preparer and accuracy-related penalties are often a CPA’s responsibility. In addition, a plaintiff’s attorney may argue that significant preparer penalties are conclusive evidence of the CPA’s tax malpractice and thus liability for the penalties.
Untimely filing penalties are mandatory. Who is to pay such penalties, the CPA or the client? CPAs should make sure they can prove the client failed to provide the required documentation on a timely basis. In some close statute of limitation circumstances, it may be prudent to obtain a dated receipt when the final tax return is delivered to the client for filing.
Negligence penalty.
Negligence includes the disregard of the law or a mis-application of the IRC or regulations. A penalty of the greater of $1,000 or 50% of the fee charged may be assessed 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.
Treasury Regulations section 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 40% or greater likelihood of being sustained on its merits. For tax shelters or certain listed transactions, the standard is more likely than not (i.e., 50%).
Willful understatement.
IRC section 6694 dictates that a willful—that is, intentional and conscious—attempt to understate tax liability or endorse another’s refund check may produce a preparer penalty. The amount of the penalty is the greater of $5,000 or 50% of the fee charged.
To avoid this penalty, the professional preparer must demonstrate that she had a reasonable support for the position at the time. The position 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 under Circular 230 section 10.36, but all factual and legal authority relied upon must have a reasonable basis. This penalty may also be abated if the preparer makes adequate disclosure on the return of the position supporting the understatement.
Aiding and Abetting
The IRS intends to curtail professional advisors assisting or participating in organized tax-related crimes, including abusive tax shelter promotion. IRC section 6701 added “aiding and abetting” penalties of $1,000 per individual return and $10,000 per partnership or corporate return. Asset overvaluation will produce a penalty of the greater of $1,000 or 30% of the shelter’s gross income.
Aiding and abetting penalties may be asserted against professionals who were associated with documents not arising under the internal revenue laws, such as an opinion letter authored by a nonpreparer. In 2014, “covered opinions” was replaced by “written advice” that “impacts a person’s obligations under the Internal Revenue laws and regulations.” This broadens the potential exposure coverage; even tax advice in the form of a written tax shelter opinion may now constitute a violation. The American Bar Association (ABA) retains the realistic possibility minimum support standard.
Tax shelters and listed transactions.
An independent analysis may be required for aggressive transactions. Circular 230 section 10.33 requires a preparer rendering an opinion on a tax shelter to provide a concise overall evaluation of whether the material tax benefits of the shelter in the aggregate are more likely than not to be realized. In Ling v. Board and K. Accounting [2615 S.W.3d 341 (Tex. App. 2008)], the court held the CPA was not excused from the duty to follow professional standards by blindly “relying on” a tax lawyer’s written opinion letter that addressed only some of the tax shelter issues. In addition, nonopinion opinion letters are no longer usually allowed. Recommending a tax shelter investment that is subsequently disallowed by the IRS can also lead to a professional malpractice claim against both the preparer and lawyer authoring the opinion letter.
Refunds.
The IRS forbids client tax refunds from being deposited directly into a tax return preparer’s account. In addition, CPAs may have an elevated duty in tax practice to known third parties. Dewar v. Smith [342 P.3d 328 (2015)] held that a CPA preparer of a client return was liable to a third party for making an address change for the receipt of a large refund check. The plaintiff did not have privity of contract with the CPA, but the CPA did know of his refund check expectancy.
Office of Professional Responsibility.
The IRS’s Office of Professional Responsibility (OPR) looks for a pattern of behavior on the part of taxpayers or preparers, such as tax fraud, fraudulent refund claims, or abusive tax shelters. A censure, suspension, or disbarment may be imposed upon a CPA involved in preparing or advising a taxpayer on an illegal tax position. IRC section 7201 provides that the IRS can enjoin a preparer from practicing; IRC section 7206 provides for potential criminal felony charges of up to three years’ imprisonment and a $100,000 fine.
Circular 230 section 10.51 extends potential disbarment to disreputable conduct, which is defined rather broadly, including giving false information to or making an improper attempt to influence a revenue officer. Such events are subject to a facts and circumstance test. The OPR may also forward the documents related to such IRS discipline to a state board of accountancy for local discipline, supervision, or cancellation of the CPA’s state license.
Confidentiality Restrictions and Tax Conflicts
The IRS has two related authoritative confidentiality restrictions and a tax advice privilege provision [Circular 230 section 10.29].
Third-party disclosure.
IRC section 7216 prohibits a CPA from disclosing a client’s tax information to a third party 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 does not qualify. 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.
Information not received in connection with a tax return preparation (such as financial statement reporting documents) is not subject to this restriction. Such records can be subpoenaed where relevant to litigation. The prudent strategy is to use a separate file for tax work to limit the discovery scope.
IRS government disclosure.
IRC section 7602 provides that the IRS may summon either the taxpayer or a third party and may require production of documents or records. IRC section 7609 requires notice to the taxpayer within three days of an IRS summons being served on third parties; this could include the taxpayer’s bank, accountant, or attorney. The taxpayer has 20 days to file a motion to quash. After 20 days, the IRS issues a certificate stating the period has expired and that the third party has no liability for compliance.
Case authority.
In Robert v. Chaple [369 S.E. 2d 482 (Ga. App. 1988)], the court held that a CPA’s disclosure to the IRS under an informal request violated IRC section 7216. The prudent position would seem to be to wait for the IRS certificate, unless the client consents in writing.
Tax advice privilege.
The 1998 IRS Restructuring and Reform Act created a tax advice attorney-client privilege under IRC section 7525, applicable to “federally authorized tax practitioners.” The privilege is limited, however, to non-criminal, nontax shelter related tax proceedings. Tax preparation information in a criminal tax case is also excluded from the privilege, even if accompanied by tax advice. Dual-purpose documents are not privileged, so separate files are a necessity [see U.S. v. Fredrick, 182 F 3d 496 (7th Cir. 1999)]. This privilege does not apply to civil litigation or any non-IRS proceeding.
Clients must have an expectation that a tax communication was to be kept confidential. Any inadvertent disclosure to the IRS may waive the privilege, however [see IBM v. IRS, 37 Fed.Cl. 599 (1997)]. This privilege does not apply to civil litigation or any non-IRS governmental proceedings.
Conflicts.
Beyond the ordinary duty of loyalty a professional always has to her clients, a joint return creates a duty of loyalty to each individual spouse. The AICPA’s Code of Professional Conduct specifies that there is no confidentiality in a divorce proceeding (1.700.030). If a divorce occurs, a CPA is not permitted to represent only one of the two joint clients unless both clients give informed consent to the conflict of interest, confirmed in writing. Prudence suggests that both spouses’ lawyers should also sign the conflict waiver.
Trust Fund Taxes and Fiduciary Duty
A CPA’s duties may involve the responsibility of making financial priority decisions for insolvent or cash-short clients. An example of the risk involved here is the potential personal liability of not depositing federal payroll trust fund taxes for one with authority and discretionary control over disbursing business funds. If deemed to be a responsible person, a CPA may be personally liable for underpayment if the IRS collection agent determines that the individual is a section 6672 fiduciary trustee [see Plett v. U.S., 185 F.3d 216 (4th Cir. 1999)].
Normally this fiduciary liability applies to CPA employees. Erwin v. IRS [111 AFR2d 2013-748 (M.C. N.C., 2013)] held that the fiduciary duty responsibility may apply to external CPAs if they have effective power over the client’s financial affairs and make cash payment priority decisions. Potential federal ERISA fiduciary duty status may also apply if a CPA operates an employee retirement trust, sets investment policy, or manages an investment portfolio.
Collection Matters and Offers in Compromise (OIC)
This author has found that insolvent clients may have unrealistic expectations about what value a CPA or tax attorney may add to the IRS’s Offer in Compromise (OIC) process. In the last 10 years, the IRS has accepted only approximately one in three OIC proposals.
The necessary disclosures required to present an OIC involve 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 be in a position to levy or garnish the client’s assets. Taxpayers should be forewarned of this possibility so that the CPA is not unjustly blamed. CPAs should also fully inform clients of all possible collection risks in the engagement letter. The engagement letter should contain the fee payment terms and often will request a substantial cash retainer.
Aggressive Tax Positions
Taxpayers often insist that their CPA take an aggressive position on a return. All the material risks—taxes, penalties, interest—should be disclosed to the client in writing. The client, not the CPA, should always make the final decision; the higher the amount involved, the greater the necessity of a thorough analysis.
Taxpayers must realize that it is their tax dollars at risk and they (and not the preparer) who will save if an aggressive position is successful. Prudence suggests that the client assume all liability for any negligence and related penalties that may result. Absent this type of protection, taxpayers may use the IRS assertion of civil preparer penalties as the basis for a civil suit.
Accounting–Tax Liability Relationship
There is a possible liability crossover area between tax compliance work and financial statement reporting. For example, a CPA may prepare a proprietor’s Schedule C or annual corporate tax return requiring the creation of post–year-end adjusting entries made to the general ledger and trial balance. Unless there is a specific engagement letter, it is difficult to defend against a claim that an examination of the records should be considered a reporting engagement. This is especially true if there are no business financial statements prepared other than the tax return, and the CPA knows the income statement will be submitted to a third party who will advance credit thereupon. SSTS 3 does not require a CPA to verify the client’s information; in comparison, GAAP and Statements on Standards for Accounting and Review Services both suggest that some investigation is prudent in all reporting engagements.
In Griffith Motors, Inc. v. Parker [633 S.W.2d 319 (Tenn. App. 1982)], 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.
Statute of Limitations Concerns
The time period within which a client must file suit against a CPA for malpractice is complicated. The most extreme default rule is that the statute is triggered only upon the receipt of the final audit assessment and notice of deficiency, that is, the date the legal obligation to pay arises and the client receives specific knowledge of the actionable claim against the CPA. One problem with this is that there is no IRS time limitation for a filed fraudulent return, which expands the corresponding potential liability period for the preparer.
In Steinmetz v. Wolgamot [2013 Il. App. 1st 121375, 995 N.E. 2d 338 (2013)], the Notice of Deficiency triggered the statute of limitations for a tax malpractice claim. In Sahadi v. Scheaffer [66 Cal.Rptr.3d 517 (2007)], the ending of the audit triggered the statute of limitations because there was no deficiency asserted by the agent for the open year in question.
Common Claims
The complexity of the tax law grows every year, and tax professionals must know and stay current on all of the rules. If a CPA is not up to date on a particular area, he should consult with another professional who has more substantial recent experience.
Theoretical tax damages.
The tax owed 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 money that the client enjoyed the use of [see Leendertsen v. Price Waterhouse, 916 P.2d 449, 81 Wa. App. 762 (1996)]. In addition, timing adjustments have no long-term consequences; as long as the statute is still open for the year in question, the taxpayer should be able to file an amended return and claim a refund for a tax advantage originally forgone. This narrows the theoretical range of viable tax claims to penalties and tax opportunities that are not recoverable.
Elections such as the NOL carryfor-ward, 1244 stock, S corporation election, nontaxable exchanges, and partnership 754 basis may provide future tax opportunities. Election deadlines should be entered on a calendaring system. For ongoing clients, there may be a duty to structure transactions to minimize the tax consequences. When 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.
Alternative Minimum Tax.
The Alternative Minimum Tax (AMT) attempts to ensure that all income is subject to some tax. Taxpayers who think they will pay no tax may expect their preparer to pay the AMT; even such unwarranted expectations should be considered by preparers.
Estate tax matters.
Accountants who handle fiduciary, gift, and estate tax work must understand all the applicable rules in detail. In terms of damages to fees, this is the highest-risk area, and overly aggressive valuations may draw preparer penalties. The high rates (potentially 40%) and aggressive IRS gift and estate auditors make the potential damages more significant than most income tax situations. In addition, estate beneficiaries may be less forgiving than the decedent would have been. Potential areas of liability include the nine-month Form 706 deadline, the 5% per month penalty, alternative valuation date election to value a closely held business or special use property, disclaimer possibilities, the 20% (or more) undervaluation penalty, generation-skipping techniques, tax allocation among beneficiary groups, QTIP election, and lost postmortem planning opportunities.
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.
Opinions on complex tax transactions.
Clients may expect CPAs 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 advisors usually do not have all the facts in hand and have not done the formal research to support the advice. If the tax matter involves large amounts, the client should pay a reasonable fee for professional input, including proper research and a written opinion letter. It may also be prudent to use a computerized projection to ensure that first impressions are accurate.
If the taxpayer insists upon an aggressive tax position, the possibility of the IRS’s challenging and reversing this position may increase. Ultimately, the taxpayer is the party who will save tax dollars from the position, and equity suggests she should assume the corresponding monetary risks of IRS disagreement.
