Supervisory Obligations Under Circular 230

Editor: Thomas J. Purcell III, CPA, J.D., Ph.D.

When Circular 230 was amended in June 2014 (T.D. 9668), a major change dealt with the standards for written advice (see Blatch, et al., “New Rules on Written Tax Advice and Other Revisions to Circular 230 and Their Effect on CPAs,” The Tax Adviser (December 2014)). Much of the commentary addressed the repeal of the “covered opinion” rules of former Section 10.35, the imposition of the competence standard of new Section 10.35, Competence, and the modifications to the provisions governing written tax advice in Section 10.37, Requirements for Written Advice. Another change that received less publicity should also be of significant interest to CPAs who oversee their firm’s tax practice—the expansion of supervisory obligations under Circular 230, Section 10.36, Procedures to Ensure Compliance.

History

For many years, Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), focused almost exclusively on the conduct of the individual practitioner. But that began to change in 2004, when Congress amended the statutory authority for Circular 230 (31 U.S.C. §330) to permit the imposition of a monetary penalty on the practitioner’s employer if the practitioner was acting on behalf of the employer and the employer knew, or should have known, that the covered practitioner’s conduct violated Circular 230.

Responding to the statutory change, the IRS adopted Circular 230, Section 10.36, in 2005. It required practitioners who had or shared principal authority and responsibility for a firm’s federal tax advice practice to take reasonable steps to ensure that the firm had adequate procedures for compliance with the (now repealed) covered-opinion rules by the firm’s members, associates, and employees. In 2011, Section 10.36 was modified to extend similar obligations to those practitioners who had or shared principal authority and responsibility for overseeing a firm’s federal tax return preparation practice. Section 10.36 was amended again in 2014 to impose obligations on practitioners who oversee their firm’s federal tax practice to take reasonable steps to ensure adequate procedures for its members, associates, and employees to comply with their obligations under subparts A, B, and C of Circular 230.

Obligations Under Section 10.36

The supervisory obligations under Section 10.36 extend to any individual subject to Circular 230 who has or shares principal authority and responsibility for overseeing his or her firm’s federal tax practice, including tax return preparation, tax advice, and preparation of other documents for submission to the IRS.

If a firm does not identify the person or persons with that authority and responsibility, the IRS may identify one or more individuals responsible for compliance with Section 10.36. Since CPA firms use a variety of management structures, determining who is subject to Section 10.36 will necessarily depend on the firm’s particular facts and circumstances.

A practitioner subject to Section 10.36 effectively has three obligations:

• Take reasonable steps to ensure that the firm has adequate procedures in effect for its members, associates, and employees for compliance with Circular 230 obligations (Circular 230, §10.36(a));
• Take reasonable steps to ensure that those firm procedures are properly followed (Circular 230, §10.36(b)(2)); and
• Take prompt remedial action when that practitioner knows or should know that one or more of the firm’s members, associates, or employees are or have engaged in a pattern or practice that violates Circular 230 in connection with their practice with the firm (Circular 230, §10.36(b)(3)).

Section 10.36 covers all obligations of a firm’s members, associates, and employees under Circular 230, subparts A, B, and C. Not only must the supervising practitioners have their firms adopt appropriate procedures to address the subpart B requirements relating to matters such as due diligence, competence, conflicts of interest, written tax advice, return positions, and client records, but they must also consider procedures to address the matters constituting disreputable conduct under subpart C. Circular 230, Section 10.51(a), defines as disreputable conduct failure to comply with subpart B obligations, as well as failure to meet other obligations under the Internal Revenue Code or other applicable laws such as:

• Conviction of any federal tax crime, any criminal offense involving dishonesty or breach of trust, or any felony under federal or state law when the conduct involved renders the practitioner unfit to practice before the IRS (Circular 230, §§10.51(a)(1)–(3));
• Giving false or misleading information to a Treasury Department officer or employee or to any tribunal authorized to pass upon federal tax matters (Circular 230, §10.51(a)(4));
• Willful failure to file a return or attempting to evade payment of federal taxes (Circular 230, §10.51(a)(6));
• Contemptuous conduct in practice before the IRS, including abusive language, false accusations, or publishing malicious or libelous matter (Circular 230, §10.51(a)(12));
• Willful failure to sign a tax return prepared by the practitioner when required (unless due to reasonable cause) (Circular 230, §10.51(a)(14));
• Willfully disclosing or using tax return information in a manner not authorized by the Internal Revenue Code (e.g., Sec. 7216) (Circular 230, §10.51(a)(15));
• Willful failure to e-file when required (Circular 230, §10.51(a)(16)); and
• Preparing all or substantially all of a federal tax return when the practitioner does not have a valid preparer tax identification number (PTIN) (Circular 230, §10.51(a)(17)).

With respect to the failure of a member, associate, or employee to file his or her own returns and pay taxes due, the IRS recognizes that these obligations are an individual responsibility and that a firm’s responsibility for such individual compliance is limited. But the IRS also believes that firm management should not ignore noncompliance with these obligations by any practitioner associated with the firm when the noncompliance is known or should be known to the firm (T.D. 9668). Interestingly, a significant number of OPR sanctions against Circular 230 practitioners involve failure by the practitioners to file income and payroll tax returns for themselves and their practices.

Suggestions for Supervising Practitioners

The IRS has acknowledged that requiring procedures to ensure compliance encourages “firms to self-regulate without the burden often associated with a rigid, one-size-fits-all approach” (T.D. 9668). Thus, determining which steps are “reasonable” and which procedures are “adequate” will necessarily take into consideration a firm’s particular facts and circumstances—firm size, nature of its tax practice, and characteristics of its clients. A procedure that is adequate for a small firm representing individuals and small businesses may be wholly inadequate for a large firm providing tax advice to multinational corporations. For example, a small firm may choose to require a second CPA to review written tax advice to a client, while a large firm may require consultation with an “opinion committee” or with designated subject matter experts. A small firm may rely on external Circular 230 training for its CPAs, while a larger firm may present proprietary Circular 230 training that integrates with the firm’s policies. Large firms may conduct formal practice reviews to assess compliance with firm policies and procedures, but a less formal process may suffice for a firm that has only a few CPAs. In each case, the adoption of any particular procedure should be based on a supervising practitioner’s determination that the procedure will ensure Circular 230 compliance by the firm’s members, associates, and employees.

In fulfilling their obligations under Section 10.36, supervising practitioners should consider periodically reviewing Circular 230 to consider and evaluate the procedures they have in place to address the various Circular 230 obligations of their members, associates, and employees. When a firm adopts a particular procedure, these supervising practitioners should consider whether it should be required by a formal policy. To promote compliance, all firm tax practice policies should be in writing and be made readily available to all firm employees. And policies should be periodically reviewed and evaluated for compliance and effectiveness in promoting the objectives of Section 10.36.

One of the most important steps to promote Circular 230 compliance is to set the right “tone” for the firm and its tax practitioners and other employees. Supervising practitioners should make clear that the firm expects all its members, associates, and employees to understand and satisfy their professional obligations under Circular 230 and AICPA standards. Requiring tax ethics training can reinforce these expectations and remind employees of the firm’s procedures that promote Circular 230 compliance. And the firm’s more experienced practitioners should be encouraged to mentor younger professionals in ethics and professionalism just as they do in other areas of tax practice. (For additional thoughts on setting an ethical culture, see Fuller and Hyde, “Establishing an Ethical Culture in a Tax Practice,” The Tax Adviser (February 2013).)

Perhaps the most difficult responsibility under Section 10.36 is taking appropriate remedial action upon discovering Circular 230 noncompliance. Most supervising practitioners would like to believe that noncompliance would never happen in their firm, but lapses in judgment and ethics can happen anywhere. It is important for supervising practitioners to be attentive to ethics issues to identify potential noncompliance as soon as possible. Once issues are identified, they should act decisively to mitigate any adverse impact on clients or the firm and to prevent any recurrence of the offending behavior. Determining the appropriate remedial actions will, of course, depend on specific facts and circumstances, but instances of significant noncompliance should prompt reconsideration of the firm’s policies and procedures and whether they need to be revised.

Finally, supervising practitioners should consider documenting the steps they have taken to address Circular 230 compliance, why they believe those steps are reasonable, and how they plan to monitor whether those steps are effective. This documentation will not only provide evidence of their attempts to comply with Section 10.36, but it will also provide a framework for periodically reviewing the firm’s policies and procedures to assure Circular 230 compliance. Supervising practitioners who cannot demonstrate reasonable efforts toward meeting their Section 10.36 obligations will have an increased risk of professional discipline if one of their employees violates Circular 230.

Conclusion

The expansion of Circular 230, Section 10.36, imposes new responsibilities on CPAs and others who oversee their firms’ federal tax practice. Section 10.36 should prompt supervising practitioners and their firms to adopt policies and procedures, monitor compliance, and address noncompliance, all with a view toward promoting the high standards of ethics and professionalism that are the hallmark of the CPA profession.

This column represents the views of the author and does not necessarily represent the views of McGladrey LLP. This column does not constitute professional advice.