Conflicts of interest in tax practice

Editor: James W. Sansone, CPA

High school English class taught that there are a few basic storylines in literature: person vs. person; person vs. society; person vs. nature; and person vs. themselves. These conflict situations can lead to great literature. But a conflict between an AICPA member and a client is not a story that a member wants to star in.

The AICPA Code of Professional Conduct’s (the AICPA Code’s) “Integrity and Objectivity Rule” (ET §1.100.001.01) states that “[i]n the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others.” The “Conflicts of Interest for Members in Public Practice” interpretation (ET §1.110.010) recognizes that “[a] conflict of interest creates adverse interest and self-interest threats” that may impair how a member applies integrity and objectivity when providing services to clients (ET §§1.110.010.02). The interpretation goes on to say that “threats may be created” when:

a. the member or the member’s firm provides a professional service related to a particular matter involving two or more clients whose interests with respect to that matter are in conflict; or

b. the interests of the member or the member’s firm with respect to a particular matter and the interests of the client for whom the member or the member’s firm provides a professional service related to that matter are in conflict.

Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R., Subtitle A, Part 10, Section 10.29(a)), defines a conflict of interest similarly:

A conflict of interest exists if —

(1) The representation of one client will be directly adverse to another client; or

(2) There is a significant risk that the representation of one or more clients will be materially limited by the practitioner’s responsibilities to another client, a former client or a third person, or by a personal interest of the practitioner.

The AICPA Code and Circular 230 identify that both (1) actual or direct conflicts of interest and (2) threats or risks of potential conflicts of interest can affect a member’s professional services to clients. Members must use professional judgment to watch for realized and potential conflicts of interest and respond to them. No matter the storyline, recognizing the conflict of interest is Step 1. The next steps are evaluation, mitigation, and communication of the conflict of interest.

Categorizing conflicts of interest

Client vs. client

Tax professionals work hard to consult with clients on tax matters and assist them with their tax-compliance requirements. Tax professionals apply experience and knowledge to find optimal tax solutions to clients’ needs. But what happens when the consultation, compliance assistance, and advice could affect two or more clients differently? The classic example of a conflict of interest occurs when tax services might favor one client or might disadvantage another client in the same transaction.

Example 1: A member prepares the S corporation tax return and the individual tax returns for the two shareholders. One shareholder wants to buy out the other shareholder and asks the member for tax advice on the best way to structure the purchase. The member has three clients: the S corporation and each of the two shareholders. Can the member advise all parties regarding the transaction fairly and effectively? Only one shareholder has asked for advice; how will the member respond to the other two parties?

The tension between the tax professional’s goal to advocate or advise for the best tax outcomes for clients and the impact on multiple clients’ competing goals or desires can be a problem. A proposed tax plan to optimize the buyout of one shareholder’s stock may be more beneficial to the buyer than the seller. An alternate plan may be preferable to the S corporation management team but less favorable to the buyer.

Other examples of client vs. client conflicts of interest can be found in these examples from the AICPA Code’s “Conflicts of Interest for Members in Public Practice” interpretation (ET §1.110.010.04):

• Advising two clients at the same time who are competing to acquire the same company when the advice might be relevant to the parties’ competitive positions;
• Providing services to both a vendor and a purchaser who are clients of the firm in relation to the same transaction;
• Representing two clients at the same time regarding the same matter who are in a legal dispute with each other, such as during divorce proceedings or the dissolution of a partnership;
• A client asks the member to provide tax or personal financial planning services to its executives, and the services could result in the member recommending to the executives actions that may be adverse to the company; or
• Providing tax or personal financial planning services for several members of a family whom the member knows to have opposing interests.

Client vs. member or member’s firm

Not all conflicts arise from transactions between clients. Transactions between the member and a client can also create a conflict of interest. The AICPA Code recognizes these self-interest threats to providing services to clients. Consider these examples (ET §1.110.010.04):

• Advising a client to invest in a business in which, for example, the immediate family member of the member has a financial interest in the business;
• Providing strategic advice to a client on its competitive position while having a joint venture or similar interest with a competitor of the client;
• Advising a client on the acquisition of a business that the firm is also interested in acquiring;
• Advising a client on the purchase of a product or service while having a royalty or commission agreement with one of the potential vendors of that product or service; or
• Referring a personal financial planning or tax client to an insurance broker or other service provider, which refers clients to the member under an exclusive arrangement.

Situations may also arise where the interests of the member or member’s firm and those of the client suddenly diverge.

Example 2: The member provides tax return preparation services to a client. The IRS completes its examination of the client’s 2022 tax return, and due to certain proposed adjustments, the Service intends to refer the case for return-preparer penalty (Sec. 6694) consideration against the member. Are the member’s interests and the client’s interest still aligned? Does this situation create a conflict of interest with respect to the member providing tax services to the client in the current year?

Firms merging or acquiring practices can also create conflicts of interest. Two clients, A and B, compete within an industry and are served by separate firms. The firms announce a plan to merge their practices. Clients A and B tell the separate firms that, once merged, the combined firm can serve only Client A or Client B, but not both. From the clients’ perspective, merging the firms creates a conflict of interest. The newly combined firm must act to address and resolve this conflict.

Members need to regularly review their relationships and services to clients to spot changes that may create conflicts of interest.

Member vs. employer

Conflicts of interest can also influence decisions of members working for an employer not in public practice. The AICPA Code’s “Conflicts of Interest for Members in Business” interpretation (ET §2.110.010) recognizes that a member in business can encounter a conflict of interest between the member and another party such as “an employing organization, a vendor, a customer, a lender, a shareholder, or other party” (ET §2.110.010.03).

Example 3: A member is employed as the CFO for a company, and the member is an owner of a business proposing to provide services to the company to document its claim for research and development (R&D) tax credits. The CFO has authority to select the vendor for the company that will provide the R&D tax credit services.

Identifying a conflict of interest

Members are to apply professional judgment to identify conflicts of interest. The AICPA Code calls for members to consider “whether a reasonable and informed third party who is aware of the relevant information would conclude that a conflict of interest exists” (ET §1.110.010.01).

Members should establish procedures for identifying circumstances that may lead to a potential conflict of interest before accepting a new client relationship, agreeing to a new service engagement, or entering into a new business relationship. These procedures help members evaluate the various interests and relationships between the parties involved and the potential impact of the proposed services the member will provide.

The AICPA Code reminds members that relationships can change over the course of an engagement, and conflicts of interest may arise that were not present when initially assessed. Members must remain vigilant to changing situations and relationships where the competing interests of various parties represented by the member or influenced by the member may challenge the member’s intention to provide services fairly.

The AICPA Code also reminds members of their responsibilities to uphold the “Confidential Client Information Rule” (ET §1.700.001) when addressing a conflict of interest (ET §1.110.010.17).

Example 4: Members can encounter problem situations when advising clients regarding merger-and- acquisition transactions. A member may identify a conflict of interest with one client in a transaction and must notify the other party to the transaction that a conflict exists but cannot fully describe the conflict due to confidentiality requirements.

Evaluating and mitigating a conflict of interest

When a potential or actual conflict of interest is identified, the member reviews the situation, the proposed services, the potential impact to the parties, and the risks to maintaining professional integrity and objectivity. The member assesses both actual and potential threats to a successful engagement.

Not all conflicts of interest are equal or carry the same level of risk to the member’s integrity and objectivity in serving clients. If the threat or risk level is unacceptable, then the member takes steps to eliminate or mitigate the threat. The AICPA Code defines an acceptable level as “a level at which a reasonable and informed third party who is aware of the relevant information would be expected to conclude that a member’s compliance with the rules is not compromised” (ET §0.400.01). That is, based on all the facts and circumstances, the conflict of interest, as mitigated, is of low risk such that the member can provide tax services in a fair manner.

A member may take actions such as the following to implement safeguards that eliminate or reduce risks to an acceptable level (ET §1.110.010.10):

• Use separate client service teams within a member’s firm and limit access to client files;
• Create separate teams for specialty tax services that are independent of the client service teams within a member’s firm;
• Implement an independent review process of the work by a knowledgeable colleague who does not otherwise have a connection with the client; or
• Consult with third parties, such as a legal counsel or a boutique service provider for a second opinion or review.

Members in business may consider taking these actions (ET §2.110.010.09):

• Restructure or segregate certain responsibilities and duties;
• Engage appropriate review or oversight;
• Withdraw from the decision-making process; or
• Consult with third parties, such as legal counsel or outside tax professionals for a second opinion or review.

Example 5: In response to the situation in Example 3, the CFO may mitigate the conflict of interest by disclosing the conflict to the company’s COO or CEO and shifting authority to choose the R&D tax credit provider to an unrelated executive or an outside consultant.

If the application of safeguards cannot reduce the threat to an acceptable level, then the member should decline to provide the service or terminate the relationship that causes or otherwise results in the conflict.

Example 6: A couple going through a contentious divorce want the member to provide tax consulting services to each of them. The member chooses to consult with Spouse 1 because the member sees that spouse as a source of tax compliance and consulting service fees going forward. The member then determines that safeguards cannot manage the conflict of interest between the member, Spouse 1, and Spouse 2. The member should decline to provide consulting services to Spouse 2.

Communicating a conflict of interest

After identifying and evaluating a conflict, the member’s next step is communicating with the client or clients. Communication is a key tool for managing the risks of a conflict of interest. It is also mandatory under the AICPA Code, even when the conflict-of-interest risk or threat level is low (ET §1.110.010.12).

Circular 230, Section 10.29(b), provides a similar directive for responding to a conflict of interest: 

[T]he practitioner may represent a client if —

(1) The practitioner reasonably believes that the practitioner will be able to provide competent and diligent representation to each affected client;

(2) The representation is not prohibited by law; and

(3) Each affected client waives the conflict of interest and gives informed consent, confirmed in writing by each affected client, at the time the existence of the conflict of interest is known by the practitioner. The confirmation may be made within a reasonable period of time after the informed consent, but in no event later than 30 days.

Provide competent and diligent representation: Circular 230 and the AICPA Code require the same assessment: Can the member provide services to all affected clients in a manner that is competent and diligent and maintains professional integrity and objectivity?

As discussed above, the answer may be yes when:

• The service requested is straightforward, with few or no uncertainties, and risks are low;
• Firms can effectively separate the client representations among different client service teams;
• The resulting outcome to each party is not significant to that party; or
• Safeguards applied can reduce risks to an acceptable level.

The answer may be no when:

• The service requested is complex, and the depth of experience needed may be found in only one member within the firm who can provide advice;
• There are insufficient resources or teams within a firm to represent the various clients;
• The resulting consequences to a party may be significant to that party;
• Safeguards cannot reduce risks to an acceptable level; or
• One or more clients decline to sign a written consent.

Obtain informed written consent: Circular 230 is clear about the need to obtain informed, written consent from the taxpayer and all parties when the member is representing the taxpayer before the IRS. It is particularly important to obtain these consents at the outset of the engagement — or as soon as a conflict is identified. A written consent is required even when a member may determine in communication with the parties that their interests are aligned, risks to the member or clients are low, and services can be provided.

Example 7: In response to the situation in Example 1, the member may inform the shareholder requesting advice of the inherent conflict. Discussions with the client requesting advice put that party on notice that the member recognizes a conflict. If all the parties agree to continue engaging with the member or the member’s firm for tax services, then, in accordance with Circular 230, the member asks for this agreement in writing. Each affected party, Shareholder 1, Shareholder 2, and an authorized officer of the S corporation, signs a statement confirming that they are informed of the conflict and wish to continue with the member or member’s firm providing services.

The AICPA Code’s “Conflicts of Interest for Members in Public Practice” interpretation lists elements to include in the consent statement (ET §1.110.010.13b):

• A description and explanation of the situation;
• Identification of the parties affected; and
• Any planned safeguards to reduce risks.

The statement should communicate enough information for the client to make an informed decision whether to provide or decline consent for the member to provide professional tax services to them. However, as noted above, client confidentiality requirements may limit what can be shared in the statement.

Developing awareness and procedures

The AICPA Tax Section created a tool to assist tax professionals in complying with the professional standard: Guidelines for Conflicts of Interest in the Performance of Federal Tax Services. The guide includes a detailed discussion of the AICPA standards and Circular 230 requirements. In the guide, members can find more example situations to develop their awareness of potential conflicts. The guide also includes sample conflict waiver statements to facilitate communication with all parties to a conflict of interest.

Members in tax practice may provide professional services to one, a few, or hundreds of clients. Members see opportunities to provide new tax services to clients and develop new business relationships almost daily. It can be challenging to recognize the relationships between clients and watch for circumstances that may create or result in a conflict of interest. Developing awareness of potential issues and implanting procedures to identify conflicts of interest can help members maintain the profession’s standards and comply with Circular 230.

Contributors

Sarah P. McGregor, CPA, is a director with Cherry Bekaert Advisory LLC in Greenville, S.C., and James W. Sansone, CPA, is managing director, Office of Risk Management, with RSM US LLP in Schaumburg, Ill. Both are members of the AICPA Tax Practice Responsibilities Committee. For more information on this column, contact thetaxadviser@aicpa.org.