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ETHICAL STANDARDS FOR TAX PRACTITIONERS 105

ETHICAL STANDARDS FOR TAX PRACTITIONERS


Glenda C. Brock Department of Accounting

To be ethical, according to Webster’s dictionary, one has to conform to the


standards of conduct of a given profession or group. Therefore, the tax professional
must comply with the legal requirements, as well as the rules of the AICPA
("American Institute of Certified Public Accountants"), to be ethical. The legal
requirements, along with penalties for noncompliance, are found in the Internal
Revenue Code of 1986 and Treasury Department Circular 230. The purpose of
this paper is to present an outline of the legal and suggested requirements for tax
practitioners. Since the law is often nebulous, the judgement of the tax professional,
the judicial system, or the Internal Revenue Service (IRS) may be the guide to
ethical behavior. Having and practicing ethical standards could result in less
litigation, less confrontations with the IRS, and a good public image.

Professional ethics are reflected in the standards of conduct practiced in a profession.


Culturally, the members of each profession determine what is ethical. Unethical behavior
practiced in a profession can affect many others in society. The S&L scandal is a prime
example. Thus it is important to encourage ethical behavior in all professions. How can society
promote ethical behavior? Do professionals need the threat of punishment in order to be
ethical? Should laws dictate ethical behavior in every profession? Can ethical behavior
instead be encouraged by doing business only with those who appear to practice ethical
standards? These are questions many professionals are asking themselves.

In tax practice, the Internal Revenue Code (“IRC”) and Treasury Circular 230 govern
ethical behavior. In addition, the AICPA has established standards for its members, as do
various bar associations for their members. Ethical behavior enacted by Congress often is
nebulous requiring the courts or the Internal Revenue Service (“IRS”) to clarify the meaning
of the statutes. For example, IRS Revenue Ruling 80-265 in 1980-2 CB 377 explains (with the
use of two scenarios) when a tax preparer is “negligent” under IRC section 6694(a) in
disregarding IRS rules. In this particular case an individual received interest from his wholly-
owned corporation from a loan. The corporation took the deduction for the interest, but the
individual did not include the interest as income on his personal return. The IRS ruled that the
tax preparer would not be deemed negligent for not including the interest unless the
information of the corporate return indicated who received the interest. If the corporation
indicated the name of the lender, then the tax preparer should have reason to believe that the
information for the individual return was not complete and would be held as negligent.

Lawyers and CPAs also have professional standards that suggest ethical behavior in
order to maintain an active status within the professional organization. The professional must
keep current as the standards do change. For example, several years ago advertising by a
CPA was considered unethical. Currently, a CPA may advertise within certain parameters.
The point is that an individual practicing in a particular area of business must know what is
ethical before they can display ethical behavior. The ultimate goal is a uniformity of ethics to
give each member and the public confidence in the integrity and work of those in the
profession. The purpose of this paper is to outline the tax professionals’ legal requirements,
the AICPA standards, and suggestions from two of the “Big Six” CPA firms as indicators of
ethical behavior.

Rules of Ethical Behavior Enacted by the Government for Tax Preparers

Treasury Department Circular 230 contains the rules and regulations that CPAs and other
qualified persons must practice when representing a client before the Internal Revenue
106 GLENDA C. BROCK Fall 1995

Service. Subpart B in particular relates the duties and restrictions of those representing their
clients. The following is a summary of some of the more basic requirements:

1. Provide information promptly to the IRS under an authorized request.

2. If an error or omission is found, the client should be notified promptly.

3. Due diligence should be exercised in determining the accuracy of all oral or written
representations.

4. There should be reasonably prompt disposition of any matter before the IRS.

5. Unconscionable fees should not be charged for representing the client before the
IRS. (The IRS first determines if it is unconscionable; ultimately, the courts do.)

There are other matters dealing with advertising, tax shelters and so forth. However, the
preceding list provides the backbone for those in tax practice. Most, if not all, require
interpretation which could be left to the IRS or the courts. For example, what is “due diligence?”
In Brockhouse v. U.S., 84-2 USTC para. 10,005, the court defined due diligence as acting “as
a reasonable, prudent person with respect to the information supplied to the preparer.”
Whether or not the definition clears up the meaning of “due diligence” is left to the judgement
of the preparer and ultimately to the IRS or the courts.

Tax preparers are assessed penalties for, among others, the understatement of taxpayer’s
liability, failure to furnish a copy of the return to taxpayer and to maintain a list or copy of each
return completed, and failure to sign the return and/or provide an identifying number. The case
of Weidmann v. U.S., 89-1 USTC para. 9197, is a prime example of a tax professional
understating the taxpayer’s liability. The IRS imposed a penalty for the understatement of tax
liability because of the negligent or intentional disregard of rules and regulations under IRC
sec. 6694. Weidmann went to court to sue for a refund of the penalties for the erroneous
assessment of the penalty. The facts of the case were as follows.

Weidmann contacted his clients that were self-employed with a home office. He then
suggested that the client execute a form to indicate that the spouse was the employee of the
self-employed client. He had the client sign a form that required the husband or wife to live on
the premises (client’s home) and have their meals there. This procedure allowed the client to
take business deductions for housing expenses and not be required to include the expenses
as income to the spouse under IRC Sec. 119. Section 119 provides, in part, that meals and
lodging on the business premises furnished to employee, his spouse, and his dependents
pursuant to employment for the convenience of the employer are excluded from income.

Weidmann tried to have the clients qualify under IRC Sec. 105 which would not require
the employee to include medical reimbursements in income from his employer. The result of
the scheme for several of the clients was a salary to the spouse of less than $250 and tax
deductions of $4,000 to $7,000. When questioned, the taxpayers indicated there was no
change in their living conditions before and after the Weidmann’s scheme. They claimed they
followed the advice of Weidmann to save taxes. The government’s expert witness was
Professor William L. Raby, a well-known author and practitioner for over 35 years. His
testimony showed his disgust of the scheme and stated that “the facts were so ‘egregious’ that
they constituted an embarrassment to the profession.”

The court ruled in favor of the IRS as the plaintiff had failed to sustain his burden of proof
that the penalties were erroneous. Furthermore, the court added just because the IRS had
ETHICAL STANDARDS FOR TAX PRACTITIONERS 107

disallowed the deductions of the taxpayers was not the cause of the imposition of the penalty.
The cause of the penalty was justified as follows:

There is nothing wrong with professional creativity and aggressiveness in


interpreting and applying the tax laws. Weidmann’s “imaginative” scheme,
however, transgressed the bounds of a novel and creative, but good faith,
construction of Code provisions. Based on Mr. Raby’s testimony, it is difficult to
believe that an experienced CPA could have had a good faith belief that such a
scheme was arguably valid.

All tax practitioners are subject to the same IRS ethical rules as CPAs and are, therefore,
subject to the same penalties. A good example is Judisch v. U.S., 85-1 USTC para. 9281.
Judisch was a lawyer, but limited her practice to tax preparation. Her usual practice was to
send her clients a questionnaire, prepare the return from the completed questionnaire, and
send the return to the client to be signed and mailed. Judisch rarely had communication with
the client unless information on the questionnaire needed clarification. The questionnaire did
not contain questions to determine if the client was entitled to a home office deduction. Yet,
questions were asked to ascertain the portion of the home that was used for the production
of income and the listing of other expenses in relation to the home office.

Without knowing if the client was eligible for the deduction, Judisch claimed a home office
deduction and included many personal expenses that did not qualify as business expenses.
Judisch admitted knowing the requirements for a home office and that deductions cannot
exceed home office income specified in IRC Sec. 280A(c)(5). Judisch was held to have
intentionally and willfully disregarded the rules and regulations under Sec. 6694(a) and (b) for
only one return where the taxpayers had no income and, in fact, no business office in the home.

Application of the Requirements


of the IRC and Professional Standards

Procedures for Accepting Clients

Several of the large CPA firms have developed procedures for accepting new clients. This
step in ethical conduct is a preventive measure. If the firm accepts clients that appear to
demonstrate ethical behavior, then there is less temptation to be unethical or a lower
probability to be faced with unethical situations. Since there is little or no published information,
it is the responsibility of each firm, large or small, to develop criteria for accepting new clients
for tax return preparation. Many of a firm’s clients for tax preparation are existing ones through
audit work or management advisory services. The firm should have sufficient information
about the client to leave little doubt about the data required to complete a Federal tax return.
Individuals that bring in their information yearly to have their Federal income tax return
completed require more scrutiny when deciding whether to accept them as clients.

The firm should set some practical guidelines when accepting a new client. If the firm has
guidelines for accepting new audit engagements, a similar approach may be appropriate for
new clients for tax work. If not, the following basic guidelines may be helpful for the firm.

1. Consult with the client about his/her business, investments or other areas that may
present tax problems.

2. Speak with the prior accountant(s) to ascertain possible problems.

3. Talk with mutual acquaintances for a general understanding of the client.


108 GLENDA C. BROCK Fall 1995

4. Depending on the nature of the client, the firm may wish to obtain a credit report of
him/her.

5. Do not indicate acceptance of the client until the firm has so agreed.

Although the list is general and a firm may desire to add additional criteria, some guidelines
should be in place for accepting new clients for tax work. Exceptions to this process would be
clients that are currently audit clients or clients who are familiar to members of the firm from
past engagements.

Accepting Client Information

The preparer’s declaration on signing the return states that the information contained in
the return is true, correct and complete based on all information of which the preparer has any
knowledge. Tax Section 132 of the AICPA Professional Standards explains that the preparer
does not have to examine or verify supporting data. However, the preparer should inquire if
the supporting data has been maintained satisfactorily when the information given appears
to be incorrect, incomplete, or inconsistent. In other words, exercise due diligence as required
by Circular 230. The CPA may wish to examine the information to his or her satisfaction. The
CPA should encourage his/her clients to maintain proper records to support the information
given on the return.

The firm is also faced with those clients that receive information from other CPA firms
(e.g., partnership K-1's). A decision must be made in regard to the information received from
outside the firm. In accepting information from other CPA firms, the CPA should:

1. Take into consideration the tax basis of the entity to the client.

2. Be sure that all tax shelters are properly reported.

3. Be sure that the clients realize their responsibility for any missing data and for
reviewing the Federal tax form.

This list is not exhaustive, and each firm should add steps that will provide the firm with
reasonable grounds for accepting the work of another firm.

Disagreements with Clients

If the client wishes to take a tax position that the CPA does not believe has a realistic
possibility of being accepted by the IRS or the courts, the CPA should consider whether or not
to prepare the return. The judgment of the CPA should include the possibility of penalties, the
reputation of the firm and the effect upon the client. Tax section 112 of the AICPA Professional
Standards suggests that the CPA may prepare and sign the return if the position is disclosed
and is not frivolous. A frivolous position is defined as one that the CPA knows is in bad faith
and is improper. The IRC Section 6702 imposes an assessable penalty of $500 on the
individual who files a return which is considered frivolous (i.e., impedes the administration of
the Federal income tax laws). The CPA should inform the client of the possible penalties if the
position is challenged by the IRS.

The judgment of the CPA is the deciding factor in matters involving errors in the return.
In all cases the CPA should inform the client as suggested by the AICPA Standards. If the client
refuses to correct the error, then the significance of the error in relation to the return may be
the deciding factor of whether or not to withdraw from the engagement. The CPA must
ETHICAL STANDARDS FOR TAX PRACTITIONERS 109

remember that in signing a return, he or she is attesting that the return is true, correct, and
complete based on the preparer’s knowledge of the information.

Confidentiality

There should be no question of whether client information is confidential. The ethics


section 301 of the AICPA Professional Standards states that client information should not be
disclosed without the consent of the client with exceptions such as legal requirements. From
the viewpoint of tax practice, the Professional Standards Section 171 iterates that the CPA
maintain a confidential relationship with the client. Internal Revenue Code Section 6712
imposes penalties on tax preparers for disclosing or using tax information without the consent
of the client. The penalties range from $250 to $10,000. Therefore, the information provided
by the client to the CPA is confidential unless the CPA is served a subpoena or similar legal
document.

Liability

The Internal Revenue Code of 1986 contains provisions to regulate the code of conduct
of income tax preparers. The IRS has the power to impose civil penalties and even institute
criminal prosecutions. While this paper is not intended to be a thorough review of the Code
on the tax preparer’s liability to the government, the CPA should be aware of the Code sections
that create the liability.

Code section 6694 includes the penalties for the understatement of the taxpayer’s liability
due to the negligent or intentional disregard of rules and regulations by the tax return preparer.
The appropriate regulations attempt to define the terms of “negligent,” “intentional,” and
“understatement.” The penalty can be as high as $500. Additionally, Revenue Procedure 80-
40, 1980-2 C.B. 774, includes factors for determining whether the penalty for negligent
disregard should be applied.

Code section 6695 contains other penalties in respect to preparing the return. Tax return
preparers must comply with Code Section 6107 in furnishing a copy of the return to the
taxpayer and retaining a copy of the return. The return must by signed by the preparer and
have a proper identifying number required by Code Sections 6109(a)(4) and 6060. The
preparer cannot endorse or negotiate a taxpayer’s check in respect to his/her taxes. The
penalties for this section usually range from $25 to $500 and can reach as high as $25,000.
In this as in all sections, the CPA should review the appropriate regulations for definitions and
interpretations.

Code Section 6696 provides the statue of limitations for the tax preparer. Generally the
time limit is three years from the time the return or claim for a refund was filed, unless it is
determined that there was a willful understatement of liability. In this case, it appears there is
no statue of limitations.

Code Section 7407 allows the IRS authority to seek injunctions against tax preparers from
continuing practice if certain behavior is found to exist under section 6694 or 6695. The case
will be heard in the District Court of the United States. The CPA can post a $50,000 bond to
stay the injunction until the case is heard.

Code Section 6701 penalizes tax preparers who aid and abet the understatement of tax
liability with amounts of $1,000 except for corporations, which is $10,000.

The preceding sections of the Code show that the IRS has the power to regulate the
behavior of tax return preparers. It is in the best interest of a firm to be aware of the
110 GLENDA C. BROCK Fall 1995

consequences of not following a code of ethics and to inform all tax preparers within the firm
of the ethical procedures necessary to eliminate the liability imposed by the government.

Clients may use their tax returns to secure loans, apply for scholarships, or for other
financial dealings, and such reliance on the return may come to haunt the CPA if proper care
was not taken in preparing the return. Therefore, the need for ethical procedures again
becomes apparent not only from the possible penalties from the government but also from
litigation of third parties.

Questionable Positions

The tax treatment of some items on the tax return may not be as determinable as others.
When the CPA is presented with such a problem, there are considerations that should be
addressed. First, what is the best position for the client? Second, are there substantial
authorities to support that position? Third, has the IRS given any indication of their position
on the tax treatment? Fourth, what are the possible consequences to electing that position
(interest and penalties) if there is a challenge by the IRS? If the answers to these questions
favor the selected position, the CPA should document the decision.

Treasury Regulations Section 1.661-3 defines “substantial authority” as between a


greater than a 50 percent likelihood of being upheld in litigation and a reasonable basis which
prevents penalties relating to negligence or intentional disregard of the rules and regulations.
In other words, it states what it is not, therefore we are to determine what it is. Subpart (b)(2)
lists the authorities that the CPA and the IRS can utilize for support of a tax position. The
regulation continues with how the position should be analyzed in relation to the authorities.

Since the regulation above requires substantial authorities, the CPA should document the
research. Documentation includes the research trail (both for and against the conclusion), the
reasoning behind the conclusion, and the authorities that support that reasoning. Regulations
Section 1.6661-3(b)(3) states that “the weight of authorities depends on their persuasiveness
and relevance as well as their source.” This section continues by stating that “a taxpayer may
have substantial authority for a position that is supported only by a well-reasoned construction
of the applicable statutory provision.” Thus, the proper documentation of a position could
eliminate additional time and effort if the position is challenged by the IRS.

Communication with the Client

One of the most important components to tax practice is communicating with the client.
A large percentage of communication is oral. The CPA should keep in mind that most
individuals have little or no knowledge of tax.

The two CPA firms that were consulted for this project require that prospective clients be
investigated before acceptance. Therefore, oral communication with these individuals is
important to let them know that their acceptance is tentative until the investigation is complete.
In the beginning stages before acceptance of a client, oral or written communication should
inform the prospective client about the firm’s policies, fees, and procedures. After accepting
the client an engagement letter should be sent that is appropriate for tax preparation.

In preparing the return or in response to tax questions from the client, the CPA may
discover problems that require researching. At the conclusion of the research, the position that
the CPA believes to be in the best interest of the client should be documented, as discussed
previously, and discussed with the client. This type of communication can be written or oral
depending on the circumstances and the nature of the problem. In either case the CPA should
ETHICAL STANDARDS FOR TAX PRACTITIONERS 111

express himself or herself in a manner that is understood by the client. The following steps may
be beneficial in relating the information to the client.

1. Review the facts of the problem.

2. Explain that the position taken is an opinion based on the information presented by
the client.

3. Relate the conclusion reached through the research.

4. In the event the client wishes to take a certain position and the CPA can support that
position, include any possible penalties or challenges that could occur.

5. Try to avoid technical terms that may be misunderstood by the client.

Again, these guidelines for communicating with the client are not exhaustive; consequently,
each firm should develop a consistent plan for such communication.

Conclusions

The primary source of ethics in tax practice is often the judgment of each tax professional,
based on the information and circumstances of the situation. All practitioners are governed by
Circular 230 and the Internal Revenue Code, and some by the AICPA or ABA Professional
Standards. The AICPA publishes a review checklist of ethical guidelines to be followed by
member CPA firms for income tax preparation.

In summary, some of the more important guidelines to consider are:

1. Investigate potential clients.

2. Keep information confidential.

3. Maintain tax positions that have substantial authority.

4. Corroborate information that appears to be incorrect or incomplete.

5. Be an advocate for the client.

6. Document all research.

7. Keep copies of all returns and support information.

8. Stress proper oral and written communication.

In response to how ethical behavior can be encouraged, it appears the courts are a major
incentive. However, CPA firms are realizing the importance of maintaining high ethical
standards which benefit the firm by keeping a good client file, avoiding unnecessary
confrontations with the IRS, and presenting a good image to the public.
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References
American Institute of Certified Public Accountants Tax Division’s “Statement on Responsibili-
ties in Tax Practice” and American Bar Association’s “Ethics and Professional Responsi-
bilities.”
Treasury Department Circular No. 230, “Regulations Governing the Practice of Attorneys,
Certified Public Accountants, Enrolled Agents, Enrolled Actuaries and Appraisers before
the Internal Revenue Service,” Subpart B - Duties and Restrictions Relating to Practice
Before the Internal Revenue Service Sections 10.25 -10.31.