What tax litigators wish other tax professionals knew

Although civil litigation and criminal prosecutions may be the exception to tax practice and not the rule,¹ the specter of a file blowing up nonetheless looms as a possibility for even the most careful and experienced tax professionals. Most CPAs, and indeed many tax lawyers, have rarely, if ever, seen the inside of a courtroom and are unfamiliar with tax litigation procedure. By virtue of their training and competence, tax professionals who work on compliance or planning matters can help clients avoid enforcement measures. However, the possibility of a civil or criminal proceeding, even if remote in most cases, nonetheless exists and means that tax professionals should consider what steps tax litigators and defense attorneys might wish, in hindsight, had been taken in the routine process of working with a client.

This article offers practical tips to help professionals engaged in tax compliance and planning to better position their clients for possible civil or criminal federal tax enforcement actions. It discusses steps that can help protect the taxpayer and the adviser and includes suggestions for interactions with both the client and the IRS. Although the recommendations offered are not foolproof, they can help to minimize the likelihood of enforcement actions and, if these actions do occur, may lead to a better outcome, achieved in a more time-effective manner. This, in turn, reduces both the expense and far-reaching consequences that litigation, whether civil or criminal, can generate for the taxpayer and the tax professional.

Client records, notes, and workpapers

To begin with the obvious, the importance of a well-maintained client file cannot be overstated. The IRS can easily obtain taxpayer records under Sec. 7602, which requires it to show only that its inquiry is related to a legitimate purpose, the information sought is relevant to that purpose, the information is not already in the IRS’s possession, and proper administrative steps were followed.² Practitioners representing clients in an IRS audit will likely experience these inquiries informally through an Information Document Request (IDR) and formally, though less frequently, through the IRS “summons” procedures. Probable cause to believe a violation of the tax laws has occurred is not required.³

Sec. 7602 permits the IRS to both access books and records and take testimony under oath; failure to comply can lead to contempt proceedings under Sec. 7604. Client documentation that is sufficient to withstand scrutiny, meaning it is correct, current, and complete,⁴ will help the taxpayer and tax professional ensure timely compliance with proper IRS demands. It will also be useful in refreshing recollections where Sec. 7602 is used to require testimony to be given under oath.

The IRS agent will request information that relates to positions taken on the tax return. As a result, organizing information in the client’s return file based on each deduction claimed or item of income reported will prove beneficial if the IRS audits the return. When generating workpapers, memoranda, or other materials, be careful not to commingle documents relating to specific positions. Organization is even more important where a tax professional works on return preparation and other matters such as tax planning. In other words, keep tax return and compliance papers pure. Tax planning and other nonreturn issues are unrelated to return preparation and should be treated as such. If they are commingled, it may be difficult to separate them years later when searching the file for documents responsive to an IDR, summons, or subpoena.

As an example, consider a memorandum that separately discusses return issues and tax planning matters. It is likely the entire memo will have to be produced to answer a summons, even if some of the information it contains is not responsive. In a worst-case scenario, the unrelated matter could lead to additional IRS inquiries, which would be an extremely unfortunate outcome for both the client and the tax professional.

Also bear in mind that the tax practitioner privilege in Sec. 7525 does not apply to criminal matters. Get an attorney involved before the case goes too far, so that materials gathered on behalf of the taxpayer need not be surrendered to the IRS. Under Kovel, the attorney-client privilege extends to persons hired by a lawyer to assist in his or her representation of the client, including accountants.⁵ Taxpayers may resist this step if the IRS appears to have dropped the matter. However, long periods of IRS silence are not necessarily golden. It may mean that the IRS is continuing the development of its civil audit or, worse, that the case has been referred for criminal investigation, which makes the ability to claim attorney-client privilege even more important.

Document all submissions to the IRS

The IRS has been understaffed for several years, and despite recently hiring 4,000 to 5,000 new employees (with more to be added to replace dwindling staff ), its backlog of mail and processing of returns has continued to be a problem.⁶ Commentators have noted that this has resulted in underreporting and under-collection of tax.⁷ It should also result in increased practitioner concern that items submitted to the IRS may become lost. To protect a taxpayer’s interests, taxpayers or their representative should retain a copy of anything submitted on paper to the IRS, and it should be sent via certified or registered mail, return receipt requested.

With respect to registered mail, Sec. 7502(c)(1) provides that the registration is prima facie evidence that the document was delivered to the address indicated and further provides that the date of registration is treated as the postmark date. Certified mail is covered under Sec. 7502(c)(2), and the regulations thereunder state, “If the document or payment is sent by U.S. certified mail and the sender’s receipt is postmarked by the postal employee to whom the document or payment is presented, the date of the U.S. postmark on the receipt is treated as the postmark date of the document or payment.”⁸ The regulation concludes, “Accordingly, the risk that the document or payment will not be postmarked on the day that it is deposited in the mail may be eliminated by the use of registered or certified mail.”⁹

Many federal tax returns are required to be submitted electronically in accordance with the IRS’s e-file program.¹⁰ It is imperative that the preparer’s e-filing procedures for income tax returns comply with the requirements of Rev. Proc. 2007-40.¹¹ An electronically filed document or return is generally treated as filed on the date of its electronic postmark.¹² The preparer should keep a copy of any e-filed return and its transmittal documentation.¹³ The IRS takes 24 to 48 hours to notify the electronic return originator if an e-filed return has been accepted or rejected.¹⁴ A copy of that notification should also be preserved as proof of filing.

It bears noting that income tax returns, as well as information-reporting forms such as Forms 3520, 5471, 5472, and FBARs¹⁵ are not deemed filed for purposes of penalties or triggering statutes of limitation unless they are filed with the correct office and in meticulous compliance with the rules and regulations.¹⁶ Therefore, even if a return is given to an IRS agent at that agent’s direction, it may not necessarily be deemed filed unless and until it makes its way to the correct office.¹⁷ Given the severity of the fines and penalties for failure to timely file these returns and reports, and the risks associated with failure to start the three-year limitation period, attention to detail is important to avoid an IRS “gotcha” moment.

Role of a good organizer

The use of a tax organizer in recording clients’ information for the tax year along with the clients’ pertinent documents is not new, but tax litigators still cringe when organizers are used ineffectively, as failures reflect poorly on both the client and the preparer. An organizer, partially complete or ignored altogether, can be used by the government against a client on many levels. It can serve as evidence that the client knew of an applicable tax obligation but chose not to comply, even though clients may argue that they did not know or have reason to know of the requirement.¹⁸

Further in this vein, the client who fills out the organizer in a negligent manner may create just as much harm to themselves as the client who ignores it altogether. Organizers prepared haphazardly or lacking in accurate and complete information can essentially become documentary evidence of negligence or reckless disregard. Worse still, if accompanied by an intent to mislead or conceal, organizer documentation could itself become evidence establishing civil fraud¹⁹ or possibly Title 26 tax crimes. A risk of such dire consequences can be avoided by making sure organizer responses are correct and complete.

A good organizer should be userfriendly and not overwhelming. It should have a balanced mix of required information and include questions that could help identify tax credits and benefits that might incentivize clients to give it their full attention. Tax software programs generally include form organizers that are updated periodically to account for changes in tax laws or IRS policies. Practitioners who identify problems with client document production in their specific practice areas (e.g., foreign bank account reporting) may wish to enhance their organizers to ensure that their clients understand the specific information requirements. In any case, the prudent practitioner should stress the value of the organizer in protecting the client and the importance of full and accurate compliance, as clients might otherwise dismiss it as a nuisance or as merely a tax practitioner’s device to limit malpractice exposure.

Besides its merits in obtaining client information, a thorough organizer will also help minimize tax preparers’ errors; prevent them from misconstruing client facts; and, ideally, limit liability exposure that might otherwise arise due to the client’s not supplying sufficient information. In cases where clients provide expenses without adequate substantiation, penalties could be imposed where the preparer did not make a sufficient inquiry. A preparer who fails to inquire whether a client has adequate records for a deduction, or who accepts the existence of records based on a taxpayer’s statement when the preparer knew the taxpayer had failed to supply similar records on examination for a previous year, could be subject to sanctions under Sec. 6694.²⁰ Discussed in further detail below, this penalty applies to the creation of an understatement of tax on a return based on an unreasonable position.²¹ Strong internal controls with respect to client tax organizers will enhance a CPA’s or professional tax preparer’s position in the event questions later arise due to return preparation.

In practice, a strong organizer should list all income sources reported on the prior year’s tax return. This will reflect that the tax preparer inquired about documents the client should have. The client will be responsible for confirming the disposition of accounts they no longer have, the existence of new accounts, and the sale or exchange of any particular property that might mandate additional computations.

Tax return preparers also need to explicitly inquire about significant matters that would trigger special reporting on a return, which can lead to civil and/or criminal penalties if reported incorrectly. Such material items include, inter alia, foreign bank account information,²² listed transactions, and “checkbox” questions regarding cryptocurrency transactions. It is imperative for tax preparers to obtain correct organizers from their clients since failures can lead to exposure to significant audit, penalty, and other risks for both the taxpayer and the tax preparer.

The importance of accurately evaluating fees and case complexities

Tax preparers who engage in compliance matters for flat fees rather than hourly compensation should regularly review their client roster and recognize matters that require more time and internal resources than might have been anticipated in the initial engagement. In a similar vein, it often happens that a small business taxpayer engages a tax professional to do compliance work, but the engagement gradually evolves to where the practitioner takes on bookkeeping, reporting, and other administrative and substantive matters for the client — all under the same engagement agreement and without an appropriate adjustment in the fees. In these times of rapid changes in the tax laws and numerous IRS initiatives, preparers are facing more situations in which they must assist the client in enhancing internal controls or performing administrative functions to ensure compliance. Recognizing these additional responsibilities, defining them, and adjusting fee structures accordingly at the outset protects the practitioner’s most valuable resource — time.

Beyond the need to earn fair compensation for hours spent, tax return preparers who fail to recognize and manage “engagement creep” may face professional consequences if they try to address the problem by spending less time than a return requires. As noted above, there are statutory penalties for failing to meet preparer standards, including an understatement penalty due to an unreasonable position. Sec. 6694 imposes a penalty for a lack of substantial authority for a tax return position unless there is a proper disclosure and a reasonable basis for the position taken. The penalty is the greater of $1,000 or 50% of the preparer’s fees for the return or claim.²³

Alternatively, preparers can be subject to an understatement penalty due to willful or reckless conduct, which applies to preparers who willfully attempt to understate the tax liability or otherwise recklessly or intentionally disregard Treasury rules or regulations. In these cases, the penalty is the greater of $5,000 or 75% of the preparer’s associated fees.²⁴ In addition to these statutory penalties, a failure to exercise due diligence can cause a practitioner to lose the right to practice before the IRS.²⁵

An illustrative dilemma underscoring the importance of a proper fee structure reared its head back in 2018 and continues to create stress for affected practitioners. The calculations necessary to determine historical retained earnings subject to the transition tax payable with respect to deferred foreign income under Sec. 965(h) have proved to take a substantial amount of time and, accordingly, increase the cost of tax return preparation. However, if the historical computations are incorrectly performed or inadequately substantiated, they can result in substantial tax deficiencies and the possibility that the transition tax becomes payable in one year versus over an eight-year period.²⁶ Taxpayers who have shopped for less expensive compliance services in this area may now find themselves under the IRS microscope and having to provide the books and records of the foreign business entity in far greater detail than they would have if they had incurred the cost necessary to make a thorough presentation on their tax returns.

To protect both the client and the preparer from more sweeping consequences than necessary, many factors should be considered in a financially viable and transparent statement of work. Ideally, the statement of work should define both the scope of the work and a predefined rate for out-of-scope work. It could even provide examples of what would automatically fall into the out-of-scope work bucket, such as a new compliance requirement due to tax law changes. Some other details can be captured, such as providing a time frame for the preparer to receive information and payment without incurring late fees or terminating the engagement.

During fee negotiations, preparers should reset their mindset and prepare key talking points that will resonate with the client. A CPA or other professional should change the discussion from cost to value. Consider using examples of where an added service allowed for more opportunities and minimized risks over the long haul. A tax-compliance professional should consider how unique a solution is relative to those of competitors. One should anticipate barriers that might prevent the client from agreeing to a new fee structure and offer options as to how they can be overcome.

Finally, a CPA or other professional should deliver the message with confidence and present the new fee structure as a fact — meaning the increase is necessary to continue providing value through deployment of the added service — rather than as a request. If applicable, the CPA or compliance professional should also offer data indicating that, in most cases, the fee for out-of-scope work is minimal compared to the overall fees. When professionals have confidence in the brand and the value provided and do a little bit of homework to tailor the approach to each client, the fee discussions can present an opportunity for candid conversations about the value of the compliance services to the client and, most importantly, protect the CPA or tax professional from having to pick between the never acceptable choice of providing an inferior product or the never attractive choice of accepting less-than-appropriate compensation for services rendered.

Stay current with issues raised by new reporting requirements and new technology

Watch for new reporting requirements: Beginning with transactions occurring in tax year 2023, Venmo and other third-party settlement organizations, which also include merchant acquiring entities of payment card transactions, must report on Form 1099-K, Payment Card and Third-Party Network Transactions, gross payments totaling more than $600 during the year for sales of goods and services made through them. In addition, such companies are required to withhold at a rate of 24% of all payments if the recipient fails to provide certain tax information to the company.

The $600 threshold was originally going to take effect for tax year 2022. However, for 2022, the reporting requirement applies only to payments for goods and services exceeding an aggregate gross amount of $20,000 in more than 200 transactions.²⁷ These rules do not apply to personal payments that are not for goods or services, such as reimbursements or small gifts between friends or family members. Tax return preparers should ask their clients if they have received any Forms 1099-K and advise them to keep records of any reportable transactions made through a payment application to properly reconcile them on a client’s return.

Report cryptocurrency transactions: Cryptocurrency is treated as property, and not as currency, for federal tax purposes.²⁸ As a result, taxpayers must keep track of their purchases and sales of cryptocurrency and of any other transactions for which payment was made or received in cryptocurrency. For 2022, Form 1040, U.S. Individual Income Tax Return, includes the following question: “At any time during 2022, did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?” A taxpayer who merely buys cryptocurrency with real currency, holds it as an investment, or transfers it between their own accounts may answer the question “no,”²⁹ but all other transactions warranting a “yes” answer are subject to reporting in accordance with the tax treatment of the underlying transaction.³⁰

Tax practitioners need to ask clients whether they have made any investments or transactions in cryptocurrency and advise them to keep proper records, including those necessary to track the tax basis of all cryptocurrencies held by the taxpayer. The IRS continues to focus on cryptocurrency and has stepped up its efforts to track crypto-transactions.³¹ Given this scrutiny, it may be advisable to revisit previously filed returns and consider whether any voluntary amendments are necessary to report unreported cryptocurrency transactions and to track and report the basis of digital assets.³²

Nonfungible tokens may be collectibles: Like cryptocurrency, the IRS treats nonfungible tokens (NFTs) as property. A creator selling or licensing an NFT is subject to ordinary income tax and, if applicable, self-employment tax. An investor’s sale of an NFT is generally treated as the sale of a capital asset subject to capital gains tax. In Notice 2023-27, the IRS announced that it intends to issue guidance related to the treatment of certain NFTs as collectibles relevant to both the treatment of an individual retirement account’s (IRA’s) investments in collectibles as a distribution from the IRA and to the applicable capital gains tax rate. Pending the issuance of that guidance, the notice states, the IRS will determine whether an NFT is a collectible “by analyzing whether the NFT’s associated right or asset is a section 408(m) collectible,” referred to as a lookthrough analysis. The notice includes an example of an NFT that certifies ownership of a gem. Since a gem is a Sec. 408(m) collectible, the NFT will also be treated as a collectible.³³

If an NFT is treated as a collectible, it is taxed at ordinary income tax rates if held for less than one year and up to the maximum long-term capital gains tax rate of 28% if held for more than one year.³⁴ By contrast, the maximum long-term capital gains tax rate for stocks and cryptocurrency is 20%. Practitioners should ask their clients whether they have created, received, sold, given, or otherwise disposed of any NFTs and accurately report any taxable NFT transactions. As with cryptocurrency, it may be advisable to review previously filed returns and determine whether it is necessary to file any amended returns.

Strategize payment decisions

Ideally, clients should pay their tax liabilities when assessed or as quickly as their finances permit, if for no other reason than to stop the accrual of interest and penalties.³⁵ However, where funds are limited, practitioners should understand that a client who makes a voluntary payment to the IRS may designate the specific liability to which it is applied.³⁶ Absent a designation, the IRS will apply the payment in whatever manner it sees fit, which is not likely to favor the taxpayer.³⁷

This is extremely important where a client has a personal tax liability, as could be the case when the client’s business faces unpaid employment taxes. Payroll tax comprises two parts: (1) Federal Unemployment Tax Act (FUTA) tax, plus the employer’s portion of Federal Insurance Contributions Act (FICA) tax, and (2) the employer’s withholding of its employees’ income tax and their share of FICA tax. This second amount is known as “trust fund” tax because the employer is taking the money from its employees’ wages and holding it to be paid over to the IRS on the employees’ behalf. If the employer falls behind on the trust fund portion, the IRS sees this not as a mere failure to pay taxes but, rather, the taking of the employees’ funds and converting them to the employer’s own use.

When this happens, the IRS has the right to pursue those trust fund taxes not only from the employer’s business but also from the business owners and any persons who were responsible for withholding the amounts and paying them to the IRS. The IRS can assess the so-called 100% penalty against these people to collect unpaid trust fund tax under Sec. 6672 and can prosecute them for the failure to pay over the funds under Sec. 7202.³⁸ This means that if a business finds itself behind on payroll taxes, all voluntary payments should always first be expressly designated to the trust fund portion of the liability for each unpaid quarter.

Another example of the importance of strategic payment decisions is when a taxpayer is seeking to use an offer in compromise (OIC) to settle a tax debt for less than the full amount owed. To qualify, a taxpayer must have filed all required returns and must remain current on all required estimated tax payments.³⁹ Failure to remain current on all filings and payments will result in the IRS’s rejection of an OIC or installment agreement on an older tax liability or, worse, cause a default on the collection alternative and revival of the old liability.

During and after the COVID-19 pandemic, the IRS experienced substantial backlogs and consequential delays and paused issuing certain collection notices required before issuing liens and levies or seizing assets. This may have lulled clients into a sense that they can pay other creditors to keep the lights on while the giant sleeps. However, the IRS recently signaled that, having made significant progress in reducing its backlog and with the pandemic officially over as a national emergency, it planned to resume issuing Notices CP14 and some other collection notices that it had paused in 2022.⁴⁰

Now that the IRS has awakened, it has far more collection power than the typical creditor, and its actions can grind a business to a halt if operating accounts are levied or assets seized. A taxpayer whose property has been seized can get the seizure released by paying the debt,⁴¹ which may be a useful option where the asset is critical to the operation of the taxpayer’s business. Again, this may mean some other obligation a taxpayer otherwise might be inclined to pay waits until more funds become available later.

The possibility of a bankruptcy introduces an additional layer of complication onto payment decisions. Section 523 of the Bankruptcy Code contains lookback rules that generally bar discharge for delinquent income tax obligations where no return was filed⁴² or where a late return was filed within two years prior to the filing of the petition.⁴³ Similarly, a discharge is denied where the tax was assessed within 240 days before filing bankruptcy⁴⁴ or where a return, if required, was due within three years before the bankruptcy petition.⁴⁵ Depending on the circumstances, these rules may mean that if bankruptcy is a possibility, funds currently available should be directed to the satisfaction of a tax debt that will survive a filing rather than resolving an ordinary payable, for example. The interaction of the tax and bankruptcy codes is extremely complex, and taxpayers should seek guidance from experienced counsel before proceeding.

Putting clients in a better position

In many cases, the expertise of tax professionals engaged in compliance or planning matters ensures that the taxpayers they serve are unlikely to ever face tax enforcement actions or be involved in tax litigation. Although the odds of audit and court action may be slim, tax professionals can add value to their client relationships by following procedures that will better position a taxpayer should enforcement or litigation loom. Many of the recommendations described in this article represent sound practice under any circumstance, and professionals are well advised to follow them.

Footnotes

¹On this point, the number of audits conducted is informative. According to a U.S. Government Accountability Office report, from 2010 to 2019 the IRS audit rate for individual income tax returns dropped from 0.9% to 0.25% (Tax Compliance: Trends of IRS Audit Rates and Results for Individual Taxpayers by Income, Rep’t No. GAO-22-104960 (May 17, 2022)). However, audit rates depend on income levels. For example, for taxpayers with total positive income greater than $10 million, the 2019 tax year audit rate as of May 1, 2022, was 8.7% (IRS Statement — Updated IRS Audit Numbers (May 26, 2022)). The Inflation Reduction Act of 2022, P.L. 117-169, signed into law by President Joe Biden on Aug. 16, 2022, provided $45.6 billion for the IRS to spend on enforcement. However, the Fiscal Responsibility Act of 2023, P.L. 118-5, rescinded a portion of that increase.

²Powell, 379 U.S. 48, 57–58 (1964), and Jewell, 749 F.3d 1295, 1297–98 (10th Cir. 2014).

³See Bisceglia, 420 U.S. 141, 146 (1975), involving a civil summons for bank records (“Of necessity, the investigative authority so provided is not limited to situations in which there is probable cause, in the traditional sense, to believe that a violation of the tax laws exists” (citing Powell, 379 U.S. at 48)). See also Ryan, 379 U.S. 61, 62 (1964).

⁴Be certain the file includes all information received from the client in whatever form of communication chosen — email, text, etc.

⁵Kovel, 296 F.2d 918 (2d Cir. 1961). See Dellinger, “Protecting a Taxpayer’s Privileges,” 53-8 The Tax Adviser 36 (August 2022), and Kossman, “CPAs and Privileged Communications,” 44 The Tax Adviser 712 (October 2013).

⁶See, e.g., Waggoner, “2023 Brings Lots of New to the IRS While Keeping One Problem: Backlogs,” The Tax Adviser (Dec. 21, 2022).

⁷Estrin, Marquez Janse, and Isackson, “The IRS Misses Billions in Uncollected Tax Each Year. Here’s Why,” NPR (April 19, 2022). The increased funding under the Inflation Reduction Act of 2022 aims in part to address this issue.

⁸Regs. Sec. 301.7502-1(c)(2).

⁹Id.

¹⁰For example, unless an exception applies, a tax return preparer filing more than 10 individual income tax returns for a calendar year is required to submit them via the IRS e-file program (Sec. 6011(e)(3)).

¹¹Rev. Proc. 2007-40 also refers to several IRS publications related to technical and other specifications for e-filing income tax returns.

¹²Regs. Sec. 301.7502-1(d)(1). An electronic postmark is defined as “a record of the date and time (in a particular time zone) that an authorized electronic return transmitter receives the transmission of a taxpayer’s electronically filed document on its host system. However, if the taxpayer and the electronic return transmitter are located in different time zones, it is the taxpayer’s time zone that controls the timeliness of the electronically filed document” (Regs. Sec. 301.7502-1(d)(3)(ii)). Note, however, that the “mailbox” rule of Sec. 7502 does not apply to electronic transmission of payments to the IRS or to documents submitted through other electronic means than via an electronic return transmitter (e.g., by fax, email, digital communication portal, or upload to an online account; see National Taxpayer Advocate, 2023 Purple Book (Dec. 31, 2022)). Also, the Tax Court follows a different rule for timely electronic filing of petitions: They must be received on or before the last date for filing by midnight in the court’s location, generally, in the U.S. Eastern time zone (Tax Court Rule 22(a); see Nutt, 160 T.C. No. 10 (2023)).

¹³Including, for example, screenshots evidencing the e-submission.

¹⁴IRS webpage, “Help With Transmitting a Return.”

¹⁵Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts; Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations; Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business; and FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR).

¹⁶Lucas v. Pilliod Lumber, 281 U.S. 245, 249 (1930); Beard, 82 T.C. 766 (1984), aff’d, 793 F.2d 139 (6th Cir. 1986).

¹⁷See Seaview Trading, LLC, 62 F.4th 1131 (9th Cir. 2023).

¹⁸In Farka, T.C. Summ. 2014-73, the taxpayer was denied innocent-spouse relief under Sec. 6015. Although not dwelt on by the court, evidence in the case included the testimony of the tax preparer, whose “normal routine” was to provide an organizer, to be returned with the relevant tax documents. Instead, the taxpayer sent back emails with attachments, not all of which could be opened.

¹⁹In Campana, T.C. Summ. 2001-159, a preparer for a taxpayer’s 1994 return sent the taxpayer an organizer that was based upon information in the return for the previous year. The taxpayer completed the organizer showing income from different sources, including “dividend” income of $38,275 that the preparer later listed on the return as “miscellaneous investment income” because there was no Form 1099 for the distribution. The taxpayer actually received $151,272 from the source, which the Tax Court described as a pyramid scheme. The taxpayer’s explanation at trial of how she came up with the reported income figure was found to be implausible; she failed to disclose to her preparer any explanation of the investments. The court held that clear and convincing evidence showed a pattern of income underreporting and an intent to mislead or conceal and therefore held the taxpayer was liable for the civil fraud penalty.

²⁰Rev. Rul. 80-266.

up>21In Schneider, 257 F. Supp. 2d 1154 (S.D. Ind. 2003), the Sec. 6694(b)(2) penalty for understatements due to willful or reckless conduct was upheld on summary judgment against a CPA-attorney and accounting firm owner who signed a client’s return claiming improper business deductions. Given information he already knew about the client and the client’s deduction history, the preparer had a duty to inquire further into claimed business deductions of the taxpayer’s personal artwork and at least verify the client’s incomplete documentation, which he admittedly did not do. Note that Sec. 6694 penalties also may apply where a practitioner is dealing with the consequences of underpricing an engagement.

²²In Schwarzbaum, the taxpayer did not disclose all of his foreign accounts to his accountants despite substantial holdings, but the court also noted that none of his accountants had asked. Nonetheless, the taxpayer was held to have willfully violated FBAR requirements for 2007 through 2009 because, having read in 2007 the instructions for the FBAR form and prepared an FBAR listing one account, he was aware of and had recklessly violated the requirements in those years (Schwarzbaum, 611 F. Supp. 3d 1356 (S.D. Fla. 2020), vacated with instructions to remand to the IRS, 24 F.4th 1355 (11th Cir. 2022)).

²³Sec. 6694(a).

²⁴Sec. 6694(b).

²⁵Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), §10.22.

²⁶Regs. Sec. 1.965-7(b)(1)(ii)(C) indicates that “[i]f a deficiency or additional liability is due to negligence, intentional disregard of rules and regulations, or fraud with intent to evade tax” during preparation of the liability calculations due to Sec. 965(h), the proration rules that allow the taxpayer to pay over an eight-year period, rather than all in one tax year, do not apply, and the deficiency or additional liability must be paid on notice and demand by the IRS or with the first installment payment.

²⁷IRS News Release IR-2022-226, “IRS Announces Delay for Implementation of $600 Reporting Threshold for Third-Party Payment Platforms’ Forms 1099-K.” See also Notice 2023-10.

²⁸Notice 2014-21. While cryptocurrency continues to be treated as property rather than as currency for federal income tax purposes, beginning in 2024, virtual currency will be treated as cash for purposes of the rule requiring a business to report the receipt of $10,000 in cash on Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business. The Infrastructure Investment and Jobs Act, P.L. 117-58, amended Sec. 6050I to define cash as including cryptocurrency and other digital assets requiring reporting, effective for return filings and customer statements furnished after Dec. 31, 2023 (Holloway and Schuldt, “Reporting Cash Receipts Over $10,000,” 53-5 The Tax Adviser 32 (May 2022)).

²⁹See IRS, “Frequently Asked Questions on Virtual Currency Transactions,” Q4 and Q5, and New Jersey Business & Industry Association, “Tax Tips: Deciphering the New Crypto Question on Form 1040” (March 22, 2022). For information about the 2022 Form 1040 itself (including the cryptocurrency question), see IRS, “About Form 1040, U.S. Individual Income Tax Return.”

³⁰Such as compensation for services, business or other income, or capital gain or loss.

³¹See, e.g., Cotter and Daderko, “IRS Continues Focus on Cryptoassets,” 52 The Tax Adviser 626 (October 2021).

³²Software tracking and reporting basis for digital assets is under consideration by the AICPA’s Virtual Currency and Digital Assets Tax Task Force. See, e.g., Nellen and Allen, “Questions About Software Tracking and Reporting for Basis of Digital Assets,” The Tax Adviser (March 13, 2023).

³³See also Waggoner, “NFTs as Collectibles: IRS Issues Guidance and Seeks Comments,” The Tax Adviser (March 21, 2023).

³⁴See Secs. 1(h)(4) and (5) regarding the calculation of “28% rate gain” and “collectibles gain.” For taxpayers with modified adjusted gross income greater than $250,000 (for a married couple filing jointly, or $200,000 for a single taxpayer), the 3.8% net investment income tax may also be imposed on gain from the sale of collectibles (Sec. 1411).

³⁵Under Sec. 6651(a)(2), a penalty of 0.5% per month applies to unpaid tax owed, increasing by an additional one-half percentage point for each additional month or portion of a month it remains unpaid, up to a maximum of 25%. Note that the IRS charges interest on penalties. See IRS webpage, “Interest.”

³⁶Muntwyler, 703 F.2d 1030 (7th Cir. 1983).

³⁷Id.

³⁸See Salzman, Hibschweiler, and Tedesco, “Employment Tax Penalties: Let’s Keep it Civil,” 49 The Tax Adviser 92 (February 2018).

³⁹See IRS webpage, “Offer in Compromise.” If the taxpayer is an employer, he or she must have made all tax deposits for the current and preceding two quarters. Note that payment representing the amount of the compromise offer or a deposit where future installment payments are envisioned must be sent with the offer (27 C.F.R. §70.482(d)(1)(ii)).

⁴⁰Waggoner, “IRS Backlog Lessens; Agency Plans to Resume Collection Notices,” The Tax Adviser (May 11, 2023).

⁴¹IRS webpage, “What Happens After My Property Is Seized and How Do I Get It Back?”

⁴²11 U.S.C. §523(a)(1)(B)(i).

⁴³11 U.S.C. §523(a)(1)(B)(ii). Discharge is denied where a return “was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition.”

⁴⁴11 U.S.C. §523(a)(1)(A), referencing 11 U.S.C. §507(a)(8)(A)(ii). Certain periods are excluded, such as when an OIC is pending. See also Salzman and Hibschweiler, “Timing Considerations of Discharging Taxes in a Chapter 7 Bankruptcy,” 43 The Tax Adviser 104 (February 2012).

⁴⁵11 U.S.C. §523(a)(1)(A), referencing 11 U.S.C. §507(a)(8)(A)(i). Extensions are included in determining when a return is last due.

Contributors

Randall P. Andreozzi, J.D., is a partner with Lippes Mathias LLP in Clarence, N.Y.; adjunct professor at the State University of New York, University at Buffalo School of Management, in Buffalo, N.Y.; and former senior trial attorney and Industry Specialization Program counsel in the IRS Office of Chief Counsel. Cassie (Phuong) Nguyen, CPA, M.S., is clinical assistant professor of accounting and law at the University at Buffalo School of Management. Arlene M. Hibschweiler, J.D., is clinical associate professor of accounting and law at the University at Buffalo School of Management. Martha L. Salzman, J.D., is clinical assistant professor of accounting and law at the University at Buffalo School of Management.

AICPA RESOURCES

Articles

Simmens, “Your Federal Tax Privilege Checklist,” 52 The Tax Adviser 318 (May 2021)

Borghino, Trivedi, and Taher, “Guidance and Enforcement Put Virtual Currencies Front and Center,” 51 The Tax Adviser 91 (February 2020)

Sawyers, “The Importance of Engagement Letters for Small Firms,” 49 The Tax Adviser 764 (November 2018)

Tax Section member resources

Annual Tax Compliance Kit (includes sample engagement letters, organizers, checklists, and practice guides)

Sample Terms and Conditions Addendum

For more information or to make a purchase, visit aicpa-cima.com/cpe-learning or call the Institute at 888-777-7077.