Navigating the Crossover in Tax Standards for Licensed and Non-Licensed Tax Practitioners in New York State

Tax Services, Including Compliance and Advisement

The AICPA’s Statement on Standards for Tax Services (SSTS) 1 (§ 1.1, “Advising on Tax Return Positions”) and SSTS 2 (§ 2.1 “Tax Positions”), establishes standards for practitioners when recommending a tax return position or preparing or signing tax returns including amended returns, claims for refund, and information returns that are filed with any taxing authority.

The guidance defines the following terms:

• Tax Return Position—“a conclusion reached when applicable tax law, regulations, caselaw, or other regulatory or recognized guidance is applied to a particular transaction, a specific set of facts and circumstances, or a controversy” (SSTS 1 § 1.1.4).
• Taxpayer—“a client, employer, or any other third-party recipient of tax services” (SSTS, Preface).

In accordance with the AICPA’s SSTS 1 §§ 1.1.5 a-c, and SSTS 2 §§ 2.1.6 a-c, when recommending a tax return position or preparing or signing a tax return, a practitioner should determine and comply with the standards set forth by the applicable taxing authority. If no such standards exist, the practitioner should not advise the taxpayer to take a tax position nor prepare or sign a tax return unless they have a “good-faith belief” that the position “has at least a realistic possibility of being sustained administratively or judicially on its merits if challenged” (SSTS 1 § 1.1.5a).

Conversely, if the applicable taxing authority has promulgated standards that surpass the “realistic possibility,” set forth in sections 1.1.5a and 2.1.6a, the practitioner should comply with the most onerous standard of such authority. Despite the aforementioned sections, a practitioner may be permitted to advise a taxpayer to assume a tax position or prepare or sign a return which includes a tax position where the practitioner believes a reasonable basis for the position exists, they have advised the taxpayer to appropriately disclose such position, and the position has in fact been appropriately disclosed (SSTS 1 § 1.1.5c,). In accordance with SSTS 1 § 1.1.6, when advising a taxpayer on tax positions, a practitioner should exercise due diligence and professional judgment, thereby granting them the right to advocate for the taxpayer in an effort to comply with such standard (SSTS 1 §§ 1.1.6 and 1.1.7). Furthermore, when applicable, the practitioner should advise the taxpayer regarding potential penalty consequences, such as those stated in IRC § 6662, of taking such a position on their tax return and discuss any potential opportunities to avoid such penalties (SSTS 2 § 2.1.7). Lastly, as stated in SSTS 2 § 2.1.8, a practitioner should not recommend a tax return position, nor prepare or sign a tax return when they have knowledge that the tax return position taken exploits the audit selection process or merely serves as an arguing position to gain leverage in a negotiation with a taxing authority.

Similarly, Circular 230 §10.34, “Standards with Respect to Tax Returns and Documents, Affidavits and Other Papers,” states that a practitioner may not “willfully, recklessly or through gross incompetence” advise a client to take a position on a tax return, nor sign a tax return or claim a refund, when the practitioner is aware that the assumed tax position:

• lacks a reasonable basis;”
• is an unreasonable position as described in § 6694(a)(2) of the Internal Revenue Code (Code) (including the related regulations and other published guidance” or
• is a willful attempt by the practitioner to understate the liability for tax or a reckless or intentional disregard of rules or regulations by the practitioner as described in § 6694(b)(2) of the Code (including the related regulations and other published guidance).”

Practitioners who fail to comply with the above standards face a penalty in accordance with § 6694(a) and (b) of the Internal Revenue Code [Circular 230 (Rev. 6-2014), § 10.34(a)(ii)(A–C)].

In addition, practitioners could face penalties under Circular 230. Pursuant to § 10.52 (a)-(a)(1), “Violations Subject to Sanction,” practitioners will be sanctioned in accordance with § 10.51, “Incompetence and Disreputable Conduct,” for willfully violating any of the regulations set forth in Circular 230. If a practitioner fails to comply with the standards set forth in SSTS 1 § 1.1 and SSTS 2 § 2.1, they are considered to have:

• provided a false opinion by asserting an unwarranted tax position under the existing federal tax laws, in accordance with § 10.51(a)(13); and
• willfully prepared a federal income tax return that is in violation of the federal tax laws, in accordance with § 10.51(a)(6).

Therefore, the practitioner is subject to the sanctions set forth in Circular 230 § 10.50, which allows the Secretary of the Treasury to censure, suspend, or disbar the practitioner from practice before the IRS [§ 10.50(a)]. In addition, the Secretary of the Treasury may impose a monetary penalty which cannot exceed the gross income derived or to be derived from the income tax position assumed [§ 10.50 (c)].

In the authors’ opinion, the AICPA guidance under SSTS 1 and 2 should have been made more explicit, mirroring the language in Circular 230, because most CPAs consult AICPA standards before reviewing Circular 230, if they review Circular 230 at all. Of course, the authors wholeheartedly believe practitioners should review all relevant standards because, as seen here, the applicable practice standards are different in many places.

Knowledge of Errors

SSTS 1 § 1.2, “Knowledge of Errors,” establishes the applicable standards for practitioners when they become aware of the taxpayer’s failure to file a required tax return, or an error in:

• a taxpayer’s previously filed return;
• a return that is the subject of an administrative proceeding; or
• a tax representation engagement (SSTS 1 § 1.2.1a-d).

As outlined in SSTS 1 § 1.2.2, an error includes “any position, omission, or method of accounting that, at the time the position is recommended or a return is filed, fails to the meet the standards set out in sections 1.1, ‘Advising on Tax Positions,’ or 2.1, ‘Tax Return Positions.’” An error “also includes a position taken on a prior year’s return that no longer meets these standards due to legislation, judicial decisions, or administrative pronouncements having retroactive effect” (SSTS 1 § 1.2.2). An item with an insignificant effect on a taxpayer’s liability is not considered an error, however.

In accordance with SSTS 1 § 1.2.6, a practitioner should promptly inform taxpayers when they have discovered any of the aforementioned failures or errors or an error in an administrative filing request or an error in advice provided to the taxpayer. A practitioner should also advise the taxpayer of the potential ramifications of the error as well as possible remedial actions to be taken; this advice may be given orally or in writing (SSTS 1 § 1.2.2). Practitioners should consider SSTS 3 § 1.3 (discussed below) when communicating any advice to taxpayers. Additionally, if the practitioner believes that a taxpayer may be exposed to fraud allegations or other criminal misconduct allegations, they should advise the taxpayer to consult with legal representation before taking any action. The practitioner should also consider consulting with their legal representation before deciding on providing advice or continuing a relationship with the taxpayer (SSTS 1 § 1.2.9, “Knowledge of Errors”).

Based upon the guidance in the SSTS, it appears as though it is a taxpayer’s responsibility to decide whether they will correct the discovered error. As many practitioners have experienced, there are instances in which the taxpayer has not taken remedial action to correct an error. When this occurs, the practitioner should consider withdrawing from preparing the current return and whether to continue a professional or employment relationship with the taxpayer. If the practitioner chooses to prepare the current year’s return, they should take necessary action to ensure the error is not repeated in the current year (SSTS 1 § 1.2.7).

While it is the practitioner’s responsibility to inform the taxpayer of such discoveries, unless required by law, the practitioner is precluded from informing the appropriate tax authority without the taxpayer’s permission (SSTS 1 § 1.2.8). Based on the AICPA’s Code of Professional Conduct, doing so represents as violation as CPAs are not allowed to divulge confidential client information without a client’s express authority (preferably written).

Similarly, Circular 230 § 10.21 states that, if a practitioner is aware that an error or omission exists in the taxpayers return, they must advise the client of such error or omission and advise them as to the consequences provided under the IRC and Treasury regulations. A practitioner is also precluded from willfully, recklessly, or through gross incompetence signing a tax return or claiming a refund which they know, or reasonably should know, is derived from a position that lacks a reasonable basis or an unreasonable position in accordance with IRC § 6694(a)(2). Failure to adhere to such standards would result in incompetent and disreputable conduct (§ 10.51) and violations subject to sanction (§ 10.52) under § 10.50 of Circular 230, which allows the Secretary of the Treasury to censure, suspend or disbar the practitioner from practicing before the Internal Revenue Service and impose a monetary penalty in an amount that cannot exceed the gross income derived from the conduct giving rise to the imposed penalty [§§ 10.50 (a),(c)].

A conflict exists in that, under the AICPA Standards, CPAs are prohibited under the Code of Professional Conduct and not specifically directed under the SSTS to contact the IRS to let them know of an error on a tax return—whereas under Circular 230 there is no such prohibition. A CPA could wind up in trouble with the AICPA, or New York State Board of Regents for strictly following the rules of Circular 230 without considering the other applicable standards.

Reliance on Tools

The evolution of technology has impacted the practice of tax preparation. From the days of handwritten tax return preparation to now data entry in tax preparation software, CPAs have always kept up with the pace of change. The professional standards governing these tools, however, have not. Therefore, in effort to address the fact that practitioners do not have professional standards that address the reliance on these technologies, the taskforce of the AICPA Tax Executive Committee responsible for updating the SSTS, created SSTS 1 § 1.4, “Reliance on Tools.” This guidance protects practitioners by identifying when they may reasonably rely on these tools while providing tax services to a taxpayer. The standard identifies the practitioners responsibility for identifying when the reliance or use of tools is appropriate by exercising professional judgment and care. In addition, it states that the use of a tool does not preclude a member’s professional obligations under the AICPA and other applicable ethical standards (SSTS 1 § 1.4.3–4).

Given the fact that Circular 230 was created to compliment the SSTS, the authors believe it should now be updated to align with the technological advances and tools addressed in such standards.

Tax Return Questions

Pursuant to the AICPA’s SSTS 2 § 2.2, “Tax Return Questions,” a practitioner should make a “reasonable effort” to obtain the necessary information from a taxpayer to answer all required questions on a tax return prior to signing off as the preparer.

Here is a situation where the AICPA and IRS standards work in unison: If a practitioner fails to adhere to the standards set forth in SSTS 2 § 2.2 then, in accordance with Circular 230 § 10.52 (a)-(a)(1), “Violations Subject to Sanction,” they will be sanctioned in accordance with § 10.51, “Incompetence and Disreputable Conduct,” for willfully violating any of the regulations set forth in Circular 230. In addition, failure to comply with such standards would result in the practitioner providing false or misleading information to the Department of Treasury, in accordance with § 10.51(a)(4) and thus be subject to the sanctions set forth in Circular 230 § 10.50, which allows the Secretary of the Treasury to censure, suspend or disbar the practitioner from practice before the IRS. In addition, the Secretary of the Treasury may impose a monetary penalty, which cannot exceed the gross income derived or to be derived from the income tax position assumed [Circular 230 (Rev.6-2014) § 10.50 (a), (c)].

Reliance on Information of Others

The AICPA’s Statement on Standards for Tax Services 2 § 2.3, “Reliance on Information of Others,” discusses a practitioner’s responsibility to examine or verify the information provided in connection with the preparation of the taxpayer’s income tax return. SSTS 2 § 2.3.2 indicates that when a practitioner is preparing or signing a return, they “may, in good faith, rely on the information” provided by the taxpayer, without verification of the information (SSTS 2 § 2.3.2). They should not, however, ignore the implications of such information and should make reasonable inquiries if the information appears to be incorrect, incomplete, or inconsistent. When possible, the practitioner should consider previous tax returns.

Secondly, the standard provides that if a tax law or applicable regulation imposes a condition with respect to a tax treatment of an item, the practitioner should pose the necessary inquiries to determine to their satisfaction whether the condition has been satisfied (SSTS 2 § 2.3.3).

Lastly, the standard states that when preparing a tax return, a practitioner should consider and leverage their own knowledge and experience from the preparation of returns from other taxpayers whose situation may be similar to the return in question. Practitioners are cautioned to consider any limitations that may be imposed by the confidentiality rules and standards previously discussed in part 1 of this article (SSTS 2 § 2.3.4).

Similarly, under Circular 230 § 10.22, “Diligence as to Accuracy,” a practitioner must exercise due diligence when preparing and filing income tax returns, documents, and other papers relating to IRS matters, as well as determining the accuracy of oral or written representations made by the practitioner to the Department of the Treasury.

Pursuant to Circular 230 § 10.52 (a)-(a)(1), “Violations Subject to Sanction,” practitioners will be sanctioned in accordance with § 10.51, “Incompetence and Disreputable Conduct,” for willfully violating any of the regulations set forth in Circular 230.

If a practitioner fails to comply with the standards set forth in SSTS 2 § 2.3, they are considered to have provided false or misleading information to the Department of Treasury, willfully prepared a federal tax return in violation of federal tax laws, and provided a false opinion through knowingly reckless conduct or gross incompetence in accordance with §§ 10.51(a) (4), (a)(6), and (a)(13), respectively. Therefore, the practitioner would be subject to the sanctions set forth in Circular 230 § 10.50, which allows the Secretary of the Treasury to censure, suspend or disbar the practitioner from practice before the IRS. The Secretary of the Treasury may also impose a monetary penalty, which cannot exceed the gross income derived or to be derived from the income tax position assumed [Circular 230 § 10.50 (c)].

Use of Estimates

The AICPA’s SSTS 2 § 2.4, “Use of Estimates,” discusses the standards that a practitioner should exercise when utilizing the estimates provided by a taxpayer in connection to the preparation of their income tax return. It states that a practitioner may use estimates (either from the taxpayer or an authorized source of the taxpayer as permitted in § 2.3) in the preparation of the taxpayer’s return if obtaining the exact data is impractical and if the practitioner deems that the estimates are reasonable based on their knowledge of the facts and circumstances (SSTS 2 § 2.4.2).

While Circular 230 does not explicitly set regulations in connection with the use of estimates when preparing a return, it does state the preparers responsibility as to accuracy as well as standards with respect to tax returns. In accordance with Circular 230 § 10.22, “Diligence as to Accuracy,” a practitioner must exercise due diligence in preparing and filing income tax returns, documents, and other papers relating to IRS matters as well as determining the accuracy of oral or written representations made by the practitioner to the Department of the Treasury. Furthermore, Circular 230 § 10.34(a), “Standards with Respect to Tax Returns and Documents, Affidavits and Other Papers,” states that a practitioner may not “willfully, recklessly or through gross incompetence” sign a tax return in which they know, or reasonably should know, lacks a reasonable basis and is an unreasonable position in accordance with IRC § 6694(a)(2).

Failure to adhere to the aforementioned standards set forth in Circular 230 will result in the practitioner being deemed to have acted recklessly or through gross incompetence by violating § 10.34 of Circular 230 [§ 10.52 (a)(2)] and will result in sanctions in accordance with § 10.51, “Incompetence and Disreputable Conduct” for willfully violating the sanctions set forth in Circular 230. Practitioners are then subject to the sanctions set forth in § 10.50, which allows the Secretary of the Treasury to censure, suspend, or disbar a practitioner from practice before the IRS. In addition, the Secretary of the Treasury may impose a monetary penalty, which cannot exceed the gross income derived or to be derived from the conduct causing the penalty [Circular 230 § 10.50 (c)].

Departure from Previous Positions

SSTS 2 § 2.5, “Departure from Previous Positions,” establishes the applicable standards for practitioners who recommend a tax return position that deviates from a previous position concluded in an administrative proceeding or court decision with respect to a previous return. In accordance with SSTS 2 § 2.5.4, a previous decision concluded in an administrative proceeding or court decision does not preclude a practitioner from recommending a different tax position or preparing or signing a return that deviates from the prior tax treatment, unless the taxpayer is obliged to a specified treatment of a tax return position in a later year. Therefore, a practitioner may recommend a tax return position or prepare and sign a tax return which deviates from the treatment of an item as concluded in either one of the aforementioned proceedings or decision so long as the requirements of SSTS 2 § 2.1, “Tax Return Positions,” are satisfied.

Providing Tax Advice & Communication

SSTS 3, “Standards for Members Providing Tax Consulting Services,” identifies the standards governing certain aspects of tax advice provided to the taxpayer by the practitioner and their responsibility to communicate if such advice has been impacted by subsequent events. SSTS 3 § 3.1.2 indicates that a practitioner should exercise their professional judgment when providing tax advice in a tax compliance engagement to ensure that such advice is competent and complies with applicable standards. SSTS 3 § 3.1.3, states that it is the practitioner’s decision on how they communicate their tax advice (i.e., orally or in writing). If the practitioner chooses to provide the advice orally to the taxpayer, they should exercise their own professional judgment to determine if there is a need to document it. But if the practitioner decides to communicate their advice in writing, the standard dictates that they should comply with any applicable tax standards related to the documentation of tax advice.

Given the trust taxpayers place in CPAs for their expertise and guidance, SSTS 3 § 3.1.4 states that practitioners should assume that their advice will impact the manner in which tax items would be reported or disclosed on a taxpayer’s return. Accordingly, the standard elaborates on further considerations to be taken into account when providing tax advice.

In accordance with SSTS 3 §§ 3.1.4 (a) and (b), when giving tax advice to a taxpayer, when applicable, the practitioner should consider: “return reporting and disclosure standards applicable to the related tax position” and “the potential penalty consequences of the return position.” When determining the applicable standards, the practitioner should adhere to the standards established in SSTS 2 § 2.1, “Tax Return Positions.”

Lastly, SSTS 3 identifies that the practitioner has no “professional obligation” to communicate the impact subsequent events may have on previously given advice, regardless of whether the taxpayers are current clients. Practitioners, however, should communicate such impact “when they are assisting in implementing procedures or plans associated with the tax advice previously provided or are specifically engaged to report on such developments by specific agreement” (SSTS 3 § 3.1.5).

The authors believe it is prudent that tax advice be in written form. Although there are no specific AICPA standards that mandate it, Circular 230 references it. CPAs should review Circular 230 carefully to ensure that their client communications comply with it.

Implications for Non-Compliance

Licensed, as well as non-licensed, tax practitioners must adhere to a multitude of standards that, at times, contradict one another.

When practitioners encounter contradictory guidance, they are expected to act conservatively and adhere to the highest, most onerous standards. If a preparer finds themselves in specific circumstances for which there is no guidance, or if the existing guidance is of a lesser standard, the practitioner should be aware of the standards set forth by the authoritative bodies discussed in this article and, again, adhere to the highest authoritative standards.

Failure to comply with the aforementioned standards, whether from the AICPA, the IRC, Circular 230, or New York State Law, can have implications for both CPA and non-CPA practitioners.

Best Practices

When considering the significant implications for practitioners if they fail to comply with the standards discussed in this article, it is imperative for practitioners to implement processes and procedures to mitigate the potential risk of exposure to noncompliance with the standards set forth by the AICPA, IRC, and Circular 230. Establishing a streamlined process to gather and maintain client information can help minimize, if not eliminate, the exposure for malpractice or professional misconduct.

Maintaining confidentiality as it applies to the aforementioned standards can be difficult due to the numerous standards that must be taken into consideration. If the appropriate steps are taken, however, compliance with these standards may not be far out of reach. Tax practitioners should consider the following best practices:

• Establish a clear understanding with the client as to what is confidential and document it.
• If a solicitation for client information is received, establish protocols to immediately notify the client and request a consent to release the information. These requests and consents should be documented and maintained by the practitioner.
• Provide courses or other resources to staff members, making them aware of what constitutes confidential client information and how such information should be protected.
• Have clear rules as to what level employees may have access to confidential information.
• Only maintain final copies of documents and other supporting materials.
• Keep documents that are protected under IRC § 7525 separate from those that are not.
• Together with the client, determine the appropriate forms of communication to exchange information related to the services being performed (Nicholas Nebolsine, “The Sec. 7525 Privilege Relating to Taxpayer Communications,” Tax Adviser, August 2018, pp. 91-94).

Practitioners may also encounter conflicts of interest that may hinder compliance with the standards mentioned above. The AICPA Code of Professional Conduct states that practitioners must identify, evaluate, and disclose such conflicts. Such conflicts of interest, however, may not always preclude a practitioner from accepting a new client or engagement. The code provides that when a practitioner encounters a conflict of interest where the threat of noncompliance is not at an acceptable level, a number of safeguards may be employed in order to reduce or eliminate such a threat (ET § 1.110.010.10).

ET §§ 1.110.010.10(a)-(c) provides a few suggestions that practitioners can implement to mitigate these threats, such as establishing clear policies and procedures to limit access to taxpayer files, implementing the use of confidentiality agreements signed by members of the firm, and using separate engagement teams. It further suggests that having a senior individual who is not involved in the engagement regularly review the applications of the safeguards, as well as the work performed, to assess whether the conclusions reached are appropriate. Practitioners also have the option to consult third parties, including legal counsel.

In situations where a practitioner is unable to implement safeguards or a threat has the possibility of being so significant that no safeguards will reduce it to an acceptable level or even eliminate it, the code states that the practitioner should: “decline to perform or discontinue any professional service which results in a conflict of interest;” or “terminate the relevant relationships or dispose of the relevant interests to eliminate the threat or reduce it to an acceptable level” (ET § 1.110.011).

As previously discussed, practitioners should also implement procedures and create and maintain documentation of policies that will notify the client of the conflict of interest and the safeguards set in place to mitigate the conflict in accordance with ET § 1.110.010.12—§ 1.110.010.18.

Navigating a Labyrinth

Determining the right course of action to successfully navigate through the labyrinth of ethical standards that licensed practitioners are expected to comply with can be difficult. This is particularly due to the fact that there is little to no precedent as to which standard has authority over the other. As noted in the analysis provided above, the authors believe that a practitioner should comply with the highest, most onerous, and authoritative standard. With proper care, CPAs and other licensed practitioners may be able to construct and implement practice and procedures that will help them ensure effortless compliance with the multitude of standards that apply to their tax practice.