By John C. Gardner, Susan L. WIlley, and Barbara J. Eide
Next Generation Self-regulation
The AICPA’s Statements on Standards for Tax Services (SSTS) supersede the longstanding Statements on Responsibilities in Tax Practice (SRTP) in two important ways: The SSTSs are based on the SRTPs and correspond with IRC and other regulations as they now exist, and, unlike the solely advisory and educational SRTPs, the SSTSs are enforceable by the AICPA and acceptable on a de facto basis by courts in certain jurisdictions, the IRS, and some government agencies.
The new SSTSs delineate CPAs’ responsibilities to their clients and the tax systems in which they practice. The statements demonstrate CPA’s commitment to tax practice standards that balance advocacy and planning with compliance and the demand to operate cost-effectively and profitably.
At the federal level, the IRC, Treasury Department Circular 230 (which applies to those practicing before the IRS), and the Tax Court rules (which apply almost exclusively to attorneys) impose preparer penalties.
Circular 230, which applies to attorneys, CPAs, enrolled agents, and actuaries that practice before the IRS, adopts the realistic possibility standard for tax return positions and imposes requirements such as due diligence and proper handling of errors and omissions.
From SRTP to SSTS
CPA tax practitioners are also subject to their own professional standards. Adherence to these standards may be mandated by state licensing statute, court decisions, or state society or AICPA membership. Between 1964 and 1977, the CPA profession developed Statements on Responsibilities in Tax Practice (SRTP), which distilled practice standards for CPAs when recommending positions on federal tax returns, preparing tax returns, using estimates, and dealing with errors on returns, as well as the form and content of advice to clients. Initially educational and advisory, many SRTPs became both de facto and de jure federal tax practice standards for CPAs by the mid-1990s.
In October 1999, the AICPA Council designated the Tax Executive Committee as a standards-setting body and charged it with promulgating enforceable professional tax practice standards. These new standards, called Statements on Standards for Tax Services (SSTS), superseded the advisory SRTPs on October 31.
At first glance, the new statements mirror the old; the name, number, and substance of each statement remain essentially the same. Nevertheless, the significance of the SSTSs differs because they are explicitly enforceable. In addition, key terminology has been changed. For example, “client” has been replaced with “taxpayer” throughout. Instead of referring to “CPAs,” the SSTSs refer to “members,” because only AICPA members can be sanctioned for violating the SSTSs. Most important, references to “the IRS” have been replaced with “the taxing authority,” which significantly broadens the scope of the new statements to reflect the applicability of these standards to all levels of tax practice, ranging from a local property tax assessment board to the appellate level of the IRS.
The SSTSs became enforceable tax practice standards at both the federal and state levels for all AICPA members on October 31. The preface to the new statements notes that—
The courts, IRS, state accountancy boards, and other professional organizations recognized and relied on the SRTPs as the appropriate articulation of professional conduct for CPAs in tax practice. In effect, the SRTPs, in and of themselves, had become de facto enforceable standards of professional practice, as CPAs were regularly held accountable for failure to follow them, through state disciplinary organizations and malpractice cases.
Recognizing that the SRTPs were already de facto enforceable, members of the AICPA Tax Division and the Tax Executive Committee successfully petitioned AICPA Council to designate tax practice standards as enforceable under Rule 201 of the AICPA Code of Professional Conduct. A task force of AICPA Tax Division members assisted the Tax Executive Committee in revising the existing statements, which were renamed in the early months of 2000.
SSTS No. 1: Tax Return Position and Interpretation No. 1-1
The revised statement, which both introduces new terminology and uses language from SRTP No. 1, applies to all tax services provided by a member and to all jurisdictions in which a member practices.
SSTS No. 1 declares that a tax return (information returns, amended returns, and claims for refund) is “primarily a taxpayer’s representation of facts.” As client advocates, CPAs have the duty to assist taxpayers in lawfully minimizing the tax burden, as long as any tax return position satisfies the realistic possibility standard. Taxpayers bear final responsibility for any tax position taken on a return.
SSTS No. 1 applies to members that recommend tax return positions and prepare or sign tax returns that are filed with any taxing authority, not just the IRS. A tax return position requires a conclusion by a member based on a taxpayer’s return and a communication about the position “as to which the taxpayer has been specifically advised by a member.” SSTS No. 1 defines taxpayer as the member’s employer, client, or other third-party tax service recipient; tax return preparation is defined as “giving advice on events that have occurred at the time the advice is given if the advice is directly relevant to determining the existence, character, or amount of a schedule, entry, or other portion of a tax return.”
Members should apply the realistic possibility standard when providing taxpayers with any professional services that involve tax return positions. Thus, no tax return position should be recommended unless the member believes in good faith that the position has a realistic possibility of being sustained if challenged judicially or administratively. Furthermore, a member should not sign or prepare a return containing a position that does not meet this good faith standard, unless it includes a nonfrivolous tax return position with appropriate disclosure. A frivolous tax return position for the purposes of SSTS No. 1 is one that is “knowingly advanced in bad faith and is patently improper”—which differs from the “patently improper” definition of frivolous in Treasury Regulations section 1.6694 regulations.
When preparing or signing a tax return or recommending a tax return position, a member should advise the taxpayer of any penalty consequences of the tax return position and, if disclosure is an option, how to avoid the penalty through adequate disclosure. Disclosure requirements should be based upon authorities in the jurisdiction appropriate to the particular circumstances and facts in the taxpayer’s case. A member who recommends a tax return position but does not prepare or sign the return will be in compliance with SSTS No. 1 if the member “advises the taxpayer concerning appropriate disclosure of the position.” Penalty avoidance through disclosure is the taxpayer’s responsibility. A member whose advice on disclosure is not heeded by the taxpayer should consult the standards.
A member should not prepare or sign a return or recommend a return position that the member knows would be used as a “mere arguing position solely in order to obtain leverage” with a taxing authority during the settlement negotiation bargaining process. No attempt should be made to recommend a position, sign, or prepare a return that includes a position that would exploit the taxing authority’s audit selection process.
Interpretation No. 1-1 explains that the realistic possibility standard is based upon the member’s judgment as to the extent of the needed research “with respect to all the facts and circumstances known to the member.” Where research is necessary, Interpretation No. 1-1 permits members to use authorities that are not permitted in evaluating whether substantial authority exists under IRC section 6662 regulations. For purposes of SSTS No. 1, acceptable authorities include sources of tax analysis and reference tools used by tax preparers and advisors, as well as articles in recognized professional publications and well-reasoned treatises. Members should also consider the type of authority; whether the taxpayer’s particular facts and circumstances can be distinguished from those covered by the court case, regulation, or other authority; and whether the authority critically analyzes the issue or merely states a conclusion.
If more than one tax return position could meet the standard, the member may discuss with the taxpayer “the likelihood that each such position might or might not cause the taxpayer’s return to be examined and whether the position would be challenged in an examination.”
Interpretation No. 1-1 contains specific illustrations to assist members in applying the realistic possibility standard. Members are encouraged to check them carefully because they are written in general language and include common practice situations, such as reliance on estimates or legal opinions on non-tax issues. Members should also examine the examples in Treasury Regulations section 1.6694-2(b)(3), which illustrate the realistic possibility standard.
SSTS No. 2: Answers to Questions on Returns
SSTS No. 2 addresses the issue of unanswered questions on a tax return. Such questions include any information requested regarding tax return instructions, regulations, or the return itself.
SSTS No. 2 requires that members “make a reasonable effort to obtain from the taxpayer the information necessary to provide appropriate answers to all questions on a tax return before signing as a preparer.” Although not all questions are equally important or applicable to a particular taxpayer, omitting pertinent information may affect the quality of the return. When a member signs a return as a preparer, the preparer’s declaration indicates that the tax return is correct, true, and complete.
If information is not “readily available and the answer is not significant in terms of taxable income or loss or the tax liability shown on the return,” omitting an answer to a question may be reasonable and require no explanation. Another acceptable reason for an omission may be that the information requested is voluminous, in which case the preparer should state that the information will be furnished upon examination. SSTS No. 2 reminds members to not omit answers simply because they may be disadvantageous to the taxpayer and to consider whether omitted information will cause the return to be “deemed incomplete.”
Although SSTS No. 1 and No. 2, Circular 230, and Treasury Regulations section 1.6694-1 require tax return positions to meet the realistic possibility standard, the requirements for meeting the standard are not identical. Thus, if omitting information on a return results in a failure to comply with the realistic possibility standard, a member could face preparer penalties as well as sanctions under Circular 230 and the SSTSs.
SSTS No. 3: Certain Procedural Aspects of Preparing Returns
SSTS No. 3 articulates the member’s obligation “to examine or verify certain supporting data or to consider information related to another taxpayer when preparing a taxpayer’s tax return.”
By preparing or signing a tax return, members indicate that the information is true, correct, and complete to the best of their knowledge and belief, based on all known information. Although the member may in good faith rely upon information provided by the taxpayer or a third party without independent verification, the member should not ignore the implication of information furnished to or known by the member. This may include information from another taxpayer’s return, if the information is relevant and necessary (considering the limitations on confidentiality of any third-party information).
Members should be cognizant of their obligation to exercise due diligence. For example, a member should make reasonable inquiries if the information appears to be incorrect, incomplete, or inconsistent and encourage the taxpayer to provide the necessary underlying documentation. Whenever feasible, the member should refer to the taxpayer’s returns for at least one prior year.
Where the tax law or regulations require specific facts and circumstances to support deductibility or other tax treatment, the member should make appropriate inquiries thereof. Although a member is obligated to examine and verify supporting data, the taxpayer is ultimately responsible for the contents of the tax return.
Parallel guidance can be found at the federal level (Treasury Regulations section 1.6694-1(e) and Circular 230), but SSTS No. 3’s guidance may not be adopted in a particular state. Treasury Regulations section 1.6694-1(e)(2) includes an example of the verification requirements outlined in the IRC section 6694 regulations.
SSTS No. 4: Use of Estimates
SSTS No. 4 indicates that the responsibility to provide the estimated data lies with the taxpayer, although a member may advise a taxpayer on the use of estimates in preparing a tax return.
Unless in conflict with methods set forth by taxing authorities, the application of judgments and approximations is acceptable and is not considered an estimate for the purposes of SSTS No. 4; neither are appraisals or valuations. In preparing or signing a tax return, the member may use a taxpayer’s estimates unless prohibited by statute or rule. The member may also use estimates if it is impracticable to obtain exact data and the estimated amounts are reasonable, based upon known facts and circumstances.
The use of estimates for federal tax purposes has been upheld in a line of cases, beginning with Cohan v. Comm’r [39 F2d 540 (2d Cir. 1930)], which permitted estimated business expense deductions [Members and taxpayers may not use the Cohan rule for estimates of expenses for travel or entertainment that are not supported by proper documents as specified in IRC section 274(d)]. Numerous court decisions over the past 70 years have also defined the circumstances and requirements for using estimates. Members should consult these decisions and similar cases in their jurisdictions.
SSTS No. 4 provides examples illustrating the appropriate use of estimates. For example, members may use estimates when the taxpayer’s records do not accurately reflect information regarding small expenditures, records are missing, or precise information about a transaction is not available.
Without more precise guidance regarding the use of estimates at the federal and state levels, SSTS No. 4 is likely to become the de facto standard for AICPA members and other tax practitioners. To comply with SSTS No. 4, members should take care that the presentation of taxpayer estimates does not imply more accuracy than can be confirmed. Although disclosure of the use of estimates is not generally required, it should be made in unusual circumstances to avoid misleading tax authorities.
SSTS No. 5: Departure from a Position Previously Concluded in an Administrative Proceeding or Court Decision
SSTS No. 5 establishes the standards for recommending a tax return position different from one taken on a prior return that was subject to an administrative or court proceeding. For purposes of this statement, administrative proceeding includes “an examination by a taxing authority or an appeals conference relating to a return or a claim for refund,” while court decision includes a decision made by “any court having jurisdiction over tax matters.”
When an administrative proceeding or court decision results in a determination based on a specific tax treatment on a prior tax return, a member should usually recommend the same treatment for subsequent years. SSTS No. 5 identifies several circumstances that may justify departure from a prior position. For example, departure is justified when supporting documentation becomes available or subsequent rulings are more favorable to the taxpayer’s current position. Departure from prior treatment may also be justified where the taxpayer yielded for settlement purposes or did not appeal an adverse decision, even if the questioned tax return position met the standards in SSTS No. 1. In addition, unless the taxpayer is bound to a specified treatment in a later year (e.g., by a formal closing agreement), the member may recommend a different tax treatment. Upon considering the taxpayer’s consent given in an earlier proceeding or an unfavorable court decision, the member may prepare and sign a tax return containing this different treatment.
In evaluating whether a position may be recommended, the member should consider equitable doctrines that may restrict a taxpayer’s ability to change the treatment of an item even if the item is not a method of accounting. For example, a member should consider the applicability of the doctrine of collateral estoppel, which prohibits the filing of repetitive lawsuits to relitigate essentially the same claim.
SSTS No. 6: Knowledge of Error: Return Preparation
A member who discovers that a taxpayer failed to file a required tax return or that a previously filed return was erroneous should both promptly inform the taxpayer and recommend measures to correct the error. This statement also governs members that neither prepared nor signed erroneous returns; members that discover an error while performing other services must notify the taxpayer of the error and recommend that it be discussed.
Consistent with the AICPA Code of Professional Conduct, members are not obligated to inform the taxing authority of the error and, in fact, may not do so without the taxpayer’s permission unless required by law. Although SSTS No. 6 does not address the issue of disclosure to successor preparers, Rule 301 of the Code for Professional Conduct prohibits disclosure without the client’s consent. To clarify the application of Rule 301, members must examine AICPA Ethics Ruling 391-3, “Information to Successor Accountant About Tax Return Irregularities.” This ruling suggests that members contacted by successor accountants can indirectly alert them to possible irregularities and errors on prior returns by recommending that the predecessor ask the client for permission “to discuss all matters freely with the successor.” This ruling was intended to make it more difficult to conceal fraud or other illegal acts by changing CPAs.
SSTS No. 6 does not require members to “recommend correction of a criminal misstatement or omission,” because the Fifth Amendment’s protections against self-incrimination presumably protect taxpayers that choose not to disclose errors to the IRS that could result in their criminal prosecution. However, if the member believes that such an error could result in criminal or fraud charges against the taxpayer, the member should advise the taxpayer to consult an attorney before taking any action.
Absent a showing of reasonable cause and good faith, tax preparers can incur an IRC section 6694(a) penalty for errors that either understate tax liability or overstate refunds because of a tax return position that lacks a realistic possibility of being sustained on its merits. Members should consult with their own attorneys before either recommending corrective action or continuing a professional or employment relationship with the taxpayer.
The statement defines error to include “any position, omission, or method of accounting” that, at the time of filing, fails to meet the realistic possibility standard in SSTS No. 1. If the error involves an erroneous method of accounting that cannot be corrected on the current tax return, SSTS No. 6 permits the member to sign the return, provided that the erroneous method is appropriately disclosed. The term error includes tax positions taken on prior returns that no longer meet the realistic possibility standard as a result of court decisions, legislative changes, and administrative pronouncements effective retroactively. Items with an “insignificant effect” on tax liability, as determined by members’ professional judgment based on all known facts and circumstances, are not considered errors, however. In determining whether an erroneous method of accounting has more than an insignificant effect upon the taxpayer’s liability, the member should consider the cumulative effect of using an erroneous accounting method as well as the effect of the method on the tax return for the current year.
Ultimately, the taxpayer is responsible for correcting errors on prior returns. Although Treasury Regulations state that taxpayers should file amended returns and pay any additional tax attributable to an error in a prior taxable year, the IRC does not require taxpayers to file amended returns to correct prior errors. The Supreme Court noted this statutory omission in its 1984 decision in Badaracco v. Comm’r (464 U.S. 386). In Badaracco, the taxpayer filed a fraudulent return and later filed a nonfraudulent amended return. The Court concluded that the unlimited statute of limitations for filing a fraudulent return applied, not the three-year limitations period applicable to nonfraudulent returns, as the taxpayer argued. In the absence of an original fraudulent return, the IRS generally accepts an amended return used to correct, modify, or supplant the original return, at least prior to an IRS audit or assertion of a tax deficiency.
If, after being informed of an error, the taxpayer chooses not to file an amended return or otherwise correct the error, the statement advises members to “consider whether to withdraw from preparing the return and whether to continue a professional or employment relationship with the taxpayer.”
Members that choose to continue in a professional or employment relationship with the taxpayer may prepare a return for the current year but “should take reasonable steps to ensure that the error is not repeated.” If a current return cannot be prepared without incorporating or repeating the prior error, SSTS No. 6 again advises members to consider withdrawal from preparing the return. A member may also sign a taxpayer’s current return involving an erroneous method of accounting if “it is past the due date to request permission to change a method of accounting meeting the standards of SSTS No. 1 ... providing the tax return includes appropriate disclosure of the use of the erroneous method.” Preparing a return that perpetuates a prior error also violates Circular 230, which requires preparers to exercise due diligence to determine that representations made to the IRS are correct and prohibits preparers from participating in submitting misleading or false information to the IRS.
Circular 230 already requires accountants, attorneys, and enrolled agents practicing before the IRS to promptly notify their clients of any known errors or omissions on the tax return or related documents. Circular 230 does not define the term error; a member should examine SSTS Nos. 6 or 7 if representing a client in an administrative hearing.
While SSTS No. 3 clarifies the obligation of members to “examine or verify” information provided by the taxpayer in preparing “true, correct, and complete” returns, SSTS No. 6 specifies how to handle errors discovered through due diligence. SSTS No. 6 further recommends that members suggest appropriate measures to correct an error on a return filed with any taxing authority (not just the IRS) and consider withdrawal if the taxpayer refuses to correct the error.
SSTS No. 6 does not explicitly require a member to inform the taxpayer of the potential consequences, including section 6662 accuracy-related penalties, of taking or not taking corrective action, but SSTS No. 1 suggests that the member discuss any position that might lead to taxpayer penalties and any opportunities to avoid such penalties through appropriate disclosure. Although the statement permits oral recommendations of corrective action or disclosure of errors to the taxpayer’s tax return preparer, the member should document in writing all notice of errors and recommended corrective action.
SSTS No. 7: Knowledge of Error: Administrative Proceedings
SSTS No. 7 applies to members that become “aware of an error in a return that is the subject of an administrative proceeding, such as an examination by a taxing authority or an appeals conference,” but not a criminal proceeding. This parallels SSTS No. 6 in both its definition of error and its exclusion of errors that have an insignificant effect on tax liability, as well as its applicability to members that neither signed nor prepared the erroneous return. The statement acknowledges that “[s]pecial considerations may apply” when members have been engaged to assist the taxpayer’s attorney in “a matter relating to the counsel’s client,” such as an administrative hearing.
SSTS No. 7 recommends that a member advise a taxpayer to consult an attorney if the member believes that fraud or criminal charges could result from tax-return errors discovered during the administrative proceeding. Similarly, members are advised to seek legal counsel if there is a possible conflict of interest or Rule 301 violation for breach of a confidential client relationship or privileged communication. These issues may be of greater significance when an error is discovered in a prior return that has become the subject of the administrative hearing.
In representing taxpayers in administrative proceedings, this statement, like SSTS No. 6, advises members to inform the taxpayer when the member becomes aware of the error and recommend corrective measures. Although the statement also prohibits disclosure to the taxing authority without the taxpayer’s permission unless required by law, it suggests that members “request the taxpayer’s agreement to disclose the error to the taxing authority.” SSTS No. 7 further advises members to urge that any disclosure be made promptly, or at least before the administrative proceeding is concluded, to avoid any perception of bad faith based on continued provision of “misleading information.”
Ultimately, the taxpayer must decide whether to correct or disclose the error to the taxing authority. If the taxpayer refuses disclosure, SSTS No. 7 advises the member to consider withdrawing from continued representation in the administrative proceedings or professional or employment relationship. When a member withdraws from representing a taxpayer during an administrative proceeding the question of confidential and privileged client communications, and the concern that withdrawal may appear to incriminate the taxpayer, assume greater significance than in cases covered in SSTS No. 6. Like SSTS No. 6, SSTS No. 7 also permits the members to make oral recommendations to the taxpayer; again, this should be documented in writing.
SSTS No. 8: Form and Content of Advice to Taxpayers
SSTS No. 8 articulates the standards that apply when members provide advice to taxpayers. When subsequent developments affect previous advice, the statement considers the circumstances under which a member has a responsibility to communicate with the taxpayer. However, the statement does not cover a member’s responsibilities when the advice is likely to be relied upon by third parties. It cautions members to be cognizant of applicable confidentiality privileges (e.g., IRC section 7525) when providing tax advice.
Because the form of advice may be oral or written and cover routine to complex subject matters, members are not required to follow a standard format or guidelines when communicating advice to a taxpayer. In deciding upon a form, members should consider the following factors:
Client communications and advice should typically include precautionary language about the current state of the tax law and a summary of the transaction or facts that affect the advice given by the member. Members are advised to provide written communications for “important, unusual, or complicated transactions.” In routine matters, oral advice may be adequate; members may use their professional judgment regarding subsequent written documentation.
Although a member may choose to communicate with the taxpayer when subsequent developments affect previous advice, the member has no responsibility to update previously given advice unless by specific agreement or unless the member is assisting in implementing that advice. In all cases, the member should inform the taxpayer that the advice reflects professional judgment based on the facts of the existing situation, that authorities are subject to change, and that subsequent developments could affect previous advice.
Any member who provides advice to clients must exercise care, because either the content or the clarity of the advice could serve as the basis for a malpractice claim. Even advice in routine matters should be given in writing, delineate the member’s responsibilities, and indicate whether the member will continue to monitor the client’s affairs on an ongoing basis.
Members can defend against possible claims in court by demonstrating adherence to the SSTSs. By showing good faith attempts at compliance, as well as due diligence in the preparation of client tax returns, members may be able to mitigate preparer penalties and malpractice claims. It is essential for leaders of practice units to acquaint themselves and their staffs with both the content and application of tax practice standards to complex client situations. All units should follow the advice given in the AICPA Tax Practice Management Manual and have copies of complete tax practitioner resources in their professional libraries. Each practice unit must educate its staff about the SSTSs and other tax practice standards through in-house training and case studies. Review and quality control procedures should incorporate the substance of these practice standards.
Documentation is essential to ensure compliance with tax practice responsibility standards. Firms should require both individual and business clients to complete and sign tax questionnaires and provide necessary documentation for tax compliance and planning purposes. Members should maintain detailed records of client interviews and all decisions regarding tax return positions, the reasoning behind them, and research documentation. In addition, written copies of client communications must be maintained to protect the client and preparer and to create a record of what was actually communicated. Firms must also ensure that their office procedures demonstrate that tax practitioner responsibility procedures are enforced as part of the firm’s quality management systems, particularly during the busy season.
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