This appendix provides a more detailed suggested solution to the five questions presented in the Campus to Clients column by Gardner, Kastantin, and Maas, “Integrating Circular 230 into the Tax Curriculum,” in the February 2012 issue of The Tax Adviser, p. 133.
1. Are tax return preparers covered under Circular 230?
Brief response: Yes.
Detailed response: Circular 230 is a compilation of rules and regulations that govern individuals and entities that practice before the IRS. There are at least two purposes for this question: (1) that the reader understands that Circular 230 governs the practitioner’s practice before the IRS, including that of tax return preparers; and (2) that the standards imposed on practitioners are minimum standards that may be further enhanced by more stringent standards imposed by the practitioner’s licensing organization such as a state bar association or a CPA’s state department of regulation and licensing, in addition to professional organizations’ rules and ethics requirements such as the American Bar Association or the AICPA (or a state CPA society).
2. Has the preparer exercised due diligence in preparation of the individual and corporate tax returns in this case?
Brief response: Probably not. Advertising expense is a corporation tax return listed item. Given the large advertising expense relative to the corporation’s total revenue, the preparer probably should have questioned this item while preparing the corporation’s tax return. In addition, it may be larger than in prior years. That questioning may have led the preparer to include the amount on the taxpayer’s personal tax return as a constructive dividend, which is not deductible by the corporation. A tax preparer should inquire or review related-party transactions when preparing the return. For their own protection, preparers need to document the communication made with the client and relied on while preparing the return.
Detailed response: Circular 230, Section 10.22, requires the practitioner to exercise due diligence in preparing, approving, and filing tax returns and other documents with the IRS. There are only a few areas, such as the earned income tax credit (EITC), in which the IRS has published specific requirements to establish that a preparer has complied with the due-diligence standard. There are no explicit guidelines for other areas of tax preparation.
Practitioners are permitted to rely on the work of others if reasonable care is exercised. The work of others referred to in this paragraph appears to relate primarily to others working under the supervision of the practitioner. This reliance does not appear to extend to work performed by the taxpayer. However, Section 10.22 refers to Section 10.34, which in subsection (d) states that a preparer generally may rely in good faith without verification upon information furnished by the client. The practitioner may not, however, ignore the implications of information furnished to, or actually known by, the practitioner, and must make reasonable inquiries if the information as furnished appears to be incorrect, inconsistent with an important fact or another factual assumption, or incomplete.
Therefore, a preparer is not required to audit a client’s books and records, though red flags and inconsistencies must be investigated and practitioners are expected to ask relevant questions of the taxpayer about information that enters into the tax return for both personal and business returns.
When preparing tax returns for entities rather than individuals, the practitioner most likely would have at least limited access to the entity’s books and records. The financial statement auditor’s concept of materiality is not explicitly referred to in Circular 230. The illustrated information does not indicate whether the CPA was engaged by the corporation for any financial accounting purposes, such as compiling, reviewing, or auditing the corporation’s financial statements.
Certainly the practitioner, who in this case is also a CPA, should nonetheless be aware of related-party transactions such as the reimbursement to the shareholder. The transaction was in the amount of $50,000, which may or may not be material in the audit sense of the word. But it was an even dollar amount and was paid by company check to the shareholder. The CPA would likely find it difficult to explain or rationalize how this transaction occurred without being noticed or questioned by the practitioner.
3. What preparer behaviors or other actions may trigger penalties and other sanctions under Circular 230?
Brief response: The failure to exercise due care in representing the taxpayer before the IRS, including failure to exercise due diligence in preparing the return, could expose the preparer to penalties and/or sanctions.
Detailed response: Based on the limited information in the illustration, we do not feel that a response can be given in the specific context of the illustration. Circular 230 includes several sections that describe sanctions and penalties for misconduct by a practitioner. Section 10.51 provides for sanctions under Section 10.50 for incompetence and disreputable conduct. Incompetence or disreputable conduct includes:
- Conviction of any criminal offense under the federal tax laws, any offense involving dishonesty or breach of trust, or any felony under federal or state law for which the conduct renders the practitioner unfit to practice before the IRS.
- Giving or participating in giving false or misleading information to Treasury or any Treasury officer or employee, or to any tribunal authorized to pass upon federal tax matters through any written or oral means.
- Solicitation of employment as prohibited under Section 10.30, the use of false or misleading representations with intent to deceive a client or prospective client in order to procure employment, or intimating that the practitioner is able improperly to obtain special consideration or action from the IRS or any officer or employee thereof. This includes inappropriately using terms such as “certified” or implying some special relationship with the IRS.
- Willfully failing to make a federal tax return in violation of the federal tax laws, or willfully evading, attempting to evade, or participating in any way in evading or attempting to evade any assessment or payment of any federal tax.
- Willfully assisting, counseling, or encouraging a client or prospective client in violating, or suggesting to a client or prospective client to violate, any federal tax law, or knowingly counseling or suggesting to a client or prospective client an illegal plan to evade federal taxes or payment thereof.
- Misappropriation of, or failure properly or promptly to remit, funds received from a client for the purpose of payment of taxes or other obligations due to the United States.
- Directly or indirectly attempting to influence, or offering or agreeing to attempt to influence, the official action of any officer or employee of the IRS by the use of threats, false accusations, duress, or coercion, by the offer of any special inducement or promise of an advantage, or by the bestowing of any gift, favor, or thing of value.
- Disbarment or suspension from practice as an attorney, CPA, public accountant, or actuary by any duly constituted authority.
- Knowingly aiding and abetting another person to practice before the IRS during a period of suspension, disbarment, or ineligibility of such other person.
- Contemptuous conduct in connection with practice before the IRS.
- Giving a false opinion, knowingly, recklessly, or through gross incompetence, including an opinion that is intentionally or recklessly misleading, or engaging in a pattern of providing incompetent opinions on questions arising under the federal tax laws.
- Willfully failing to sign a tax return prepared by the practitioner when the practitioner’s signature is required by federal tax laws unless the failure is due to reasonable cause and not due to willful neglect.
- Willfully disclosing or otherwise using a tax return or tax return information in a manner not authorized by the IRS.
- Willfully failing to file on magnetic or other electronic media a tax return prepared by the practitioner when the practitioner is required to do so by the federal tax laws unless the failure is due to reasonable cause and not due to willful neglect.
- Willfully preparing all or substantially all of, or signing, a tax return or claim for refund when the practitioner does not possess a current or otherwise valid preparer tax identification number (PTIN) or other prescribed identifying number.
- Willfully representing a taxpayer before an officer or employee of the IRS unless the practitioner is authorized to do so by Circular 230.
Section 10.50 includes the authority to censure, suspend, disbar, disqualify, or impose monetary penalties on any practitioner for misconduct described above. The IRS may accept a practitioner’s offer of consent to be sanctioned under Section 10.50 in lieu of instituting or continuing a proceeding under Section 10.60(a). The sanctions imposed by Section 10.50 shall take into account all relevant facts and circumstances. The terms “willfully,” “knowingly,” and “recklessly” are pervasive in Circular 230. These three terms do not necessarily have the same meaning in various parts of federal tax laws and regulations.
4. Is the tax preparer in this example exposed to Circular 230 penalties and other sanctions as a result of preparing income tax returns for the shareholder and/or the C corporation?
Brief response: This depends on IRS interpretations.
Detailed response: Section 10.34, paragraph (d), Relying on information furnished by clients, states that a practitioner advising a client to take a position on a tax return, document, affidavit, or other paper submitted to the IRS, or preparing or signing a tax return as a preparer, generally may rely in good faith without verification upon information furnished by the client. The practitioner may not, however, ignore the implications of information furnished to, or actually known by, the practitioner, and must make reasonable inquiries if the information as furnished appears to be incorrect, inconsistent with an important fact or another factual assumption, or incomplete. Unless the practitioner in this illustration can demonstrate via documentation that “reasonable inquiries” were made, it is likely that the practitioner could, at a minimum, be judged reckless and thus be exposed to Circular 230 penalties.
5. Are taxpayers covered under Circular 230?
Brief response: Not directly. Tax preparers are covered. Apart from Circular 230, tax law allows the IRS to collect unpaid tax, interest, and penalties from taxpayers when tax liability is understated on a tax return.
Detailed response: This question complements question 1. The purpose of this question is to demonstrate that taxpayers are technically excluded from the scope of Circular 230. But the reader must understand that, though Circular 230 does not govern taxpayers directly, it is clear that, in practicing before the IRS, tax preparers are representing taxpayers. Work performed for the taxpayers becomes part of the practitioner’s practice before the IRS.
Circular 230, as amended, effective August 2, 2011, includes five subparts: A—the authority to practice before the IRS; B—duties and restrictions relating to such practice; C—practitioner sanctions for violating the regulations; D—rules applicable to disciplinary proceeds against practitioners; and E—general provisions, including those relating to availability of official records. Each subpart deals with work performed by the practitioner but within the context of work based on the taxpayer’s financial and other relevant income tax information.
Annette Nellen is a professor in the Department of Accounting and Finance at San José State University in San José, CA. She is a former member of the AICPA Tax Division’s Tax Executive Committee and is a current member of the Tax Division’s Individual Income Tax Technical Resource Panel. John Gardner is a professor emeritus, Joseph Kastantin is an associate professor, and William Maas is an assistant professor at the University of Wisconsin–La Crosse in La Crosse, WI. For more information about this column, please contact Prof. Maas at firstname.lastname@example.org.