New standards for tax practice.

Has anything changed for AICPA members who provide tax services?

Following eight years of debate, the AICPA tax executive committee voted in July to adopt eight Statements on Standards for Tax Services (SSTSs) as enforceable standards for AICPA members. While this means that previously voluntary standards are now enforceable, the rules themselves are little changed.

The SSTSs have their origin in the Statements on Responsibilities in Tax Practice (SRTPs), which the AICPA issued between 1964 and 1991 to give CPAs a "body of advisory opinions on good tax practice." The SSTSs and Interpretation 1-1 superseded and replace the SRTPs and their Interpretation 1-1 effective October 31.

The new standards reflect previous committee decisions, including the conclusion that any enforceable standards should be restricted to AICPA members (the SRTPs referred to "CPAs" while the SSTSs refer to "members"). The SSTSs also clarify the scope of the standards vis-a-vis members in industry (the SRTPs discussed "clients," and were therefore silent on their application to members in industry; the SSTSs generally refer to "taxpayers").

In the debate over whether to adopt the SSTS, there was general concern over whether members in tax practice needed standards and, if so, whether they should be enforceable. Further debate involved the importance of AICPA self-regulation efforts vs. member concern with "standards overload" in the highly regulated tax practice area.

THE CASE FOR ENFORCEABLE STANDARDS

In comment letters on the SSTS exposure draft, several members questioned the need for enforceable tax practice standards. A strong case for the SSTSs is laid out in their preface, which says, "Practice standards are the hallmark of calling one's self a professional. Members should fulfill their responsibilities as professionals by instituting and maintaining standards against which their professional performance can be measured. Compliance with professional standards of tax practice also confirms the public's awareness of the professionalism that is associated with CPAs as well as the AICPA."

While general concepts of professionalism strongly favor enforceable standards, there are more pragmatic reasons for making such a move. Even though the SRTPs were advisory, the courts, the IRS, state accountancy boards and other professional organizations recognized and relied on them as the articulation of professional conduct in a CPA tax practice. The SRTPs became de facto enforceable standards.

In malpractice cases against CPAs, for example, the courts viewed the SRTPs as the standards to which CPAs were actually held. Defense attorneys said the lack of enforceability made the SRTPs a sword (plaintiffs could cite allegations of failure to comply as evidence a practitioner had not exercised due professional care), but not a shield (when a practitioner followed the SRTPs, plaintiffs--or more precisely, their attorneys--would dismiss them as irrelevant, arguing they were merely educational).

A number of states explicitly incorporated the SRTPs as enforceable rules of conduct for their licensees. Other states implicitly incorporate them as enforceable rules through the use of rules that generally recognize AICPA tax guidelines as their practice standards. (See the box for more details.)

Although other tax practice standards exist, most notably Treasury Department Circular 230 and the penalty provisions of the Internal Revenue Code, they are limited.

* They do not provide the depth of guidance found in the SSTSs.

* They may be considered to take an unrealistic or over-simplified view of the complexities of tax practice.

* In almost all cases they apply only to federal income tax practice.

Further, the IRC provisions and Circular 230 are not ethical standards; the code sections concern monetary penalties and Circular 230 focuses on the right to represent clients before the IRS.

In light of the 20-year history of the SRTPs as advisory opinions, it is understandable that some questioned the switch to enforceable standards. The tax executive committee and other AICPA bodies debated the need for enforceable tax practice standards at great length. The committee believes the ultimate conclusion recognizes the pros and cons of the matter, but holds that enforceable standards are preferable. The strongest argument for them is that the profession is better served when it regulates itself rather than having third parties do it.

Several comment letters voiced concerns about apparent inconsistencies between the IRC and the SSTSs. They said the standards set too high a bar for members compared with others in tax practice, notably commercial tax preparers. However, while the tax law clearly regulates the conduct of tax advisers, it doesn't follow that the law should be a substitute for professional standards. A professional standard must do more than judge a member's conduct by whether it could lead to taxpayer or return preparer penalties.

In addition, unlike the IRC, the statements extend beyond federal income tax practice. In some cases, the standards are purposely more permissive than the IRC or Circular 230, particularly when those standards simply do not recognize the realities of tax practice.

Example. The language of IRC section 6102 clearly includes the assumption that taxable income can be computed to the penny, with rounding conventions applied only as each number is entered on the tax return. SSTS no. 4 recognizes members may not be able to attain this level of precision--even when the taxpayer has tried to keep accurate books and records. It provides standards more suited to members' practices than the IRC. Similarly, SSTS no. 1, paragraph 7, recognizes that a member may rely on a treatise or article in determining whether a realistic possibility of success exists for a particular tax return position. That is more attuned to members' practices than the regulations, which expressly provide that treatises and articles are not relevant when determining the realistic possibility of success.

THE ENFORCEMENT PROCESS

Some of the comments on the ED expressed concern about how the AICPA would or could enforce the SSTSs. Some wondered if it would be possible to be denied AICPA membership because of a practitioner's failure to conform to the SSTSs, either because he or she was unaware of a standard or determined that extenuating circumstances rendered a standard inapplicable. A number of letters questioned the comprehensibility and precision of terms such as tax services, good-faith belief, appropriately disclose, bad faith, reasonable effort, voluminous, error and insignificant effect. Members wondered how the AICPA could enforce rules containing such subjective language.

The SSTSs were written in as simple and objective a manner as possible. However, by their nature, ethical standards provide for an appropriate range of behavior that recognizes the need for interpretations to meet a broad array of factual situations. The SSTSs acknowledge this need by, in some instances, providing relatively subjective rules and leaving certain terms undefined. These terms, however, are generally rooted in tax concepts, and therefore tax practitioners should understand them. The AICPA's enforcement of these rules, as part of the AICPA Code of Professional Conduct, Rule 201--General Standards, and Rule 202--Compliance With Standards, will be flexible and handled on a case-by-case basis. In connection with ethics rulings, the code says, "Members who depart from such rulings in similar circumstances will be requested to justify such departures." In other words, the AICPA generally would view an inadvertent or reasonable departure as justified, and thus would not result in loss of membership or other sanction.

INFORMATION ON THE SSTSs

The SSTSs were published in the Journal of Accountancy (See JofA, Oct.00, page 139). Readers can also access the text on the Internet at www.aicpa.org/members/div/tax/index.htm (under "Resources"). Here is a brief summary of the standards.

SSTS no. 1, Tax Return Positions. This statement applies when members recommend tax return positions and prepare or sign tax returns (including amended returns, claims for refund and information returns) filed with any taxing authority. The standards recognize members' responsibilities to both taxpayers and to the tax system.

For example, in reaching a conclusion, a member may consider a well-reasoned construction of the applicable statute, well-reasoned articles or treatises or pronouncements issued by the applicable taxing authority, regardless of whether IRC section 6662 and its regulations would treat them as authority.

Interpretation no. 1-1, "Realistic Possibility Standard," of SSTS no. 1. Interpretation no. 1-1 updates and restates Interpretation 1-1 to SRTP no. 1. It explains various aspects of Statement no. 1, as well as providing examples of fact patterns to illustrate when the realistic possibility standard has or has not been met.

SSTS no. 2, Answers to Questions on Returns. Should a member sign the preparer's declaration on a tax return if one or more questions on the return have not been answered? Under this standard, in general, a member should make a reasonable effort to obtain from the taxpayer the information necessary to provide appropriate answers to all questions before signing a return.

SSTS no. 3, Certain Procedural Aspects of Preparing Returns. This statement outlines members' obligation to examine or verify certain supporting data or to consider information related to another taxpayer when preparing a tax return. In preparing or signing a return, a member may in good faith rely, without verification, on information the taxpayer or a third party furnishes. However, a member should make reasonable inquiries if the information appears incorrect, incomplete or inconsistent either on its face or on the basis of other facts. Whenever feasible, a member should refer to the taxpayer's returns for one or more prior years.

If the tax law or regulations impose a condition on the deductibility or other tax treatment of an item, such as taxpayer maintenance of books and records or substantiating documentation to support the reported deduction or tax treatment, a member should make appropriate inquiries to determine to his or her satisfaction whether the taxpayer has met the condition.

SSTS no. 4, Use of Estimates. Unless prohibited by statute or by rule, a member may use the taxpayer's estimates if it is not practical to obtain exact data and if he or she determines the estimates are reasonable based on known facts and circumstances. The taxpayer is responsible for providing the estimated data. If the member uses the taxpayer's estimates, he or she should present them in a manner that does not imply greater accuracy than exists.

SSTS no. 5, Departure From a Position Previously Concluded in an Administrative Proceeding or Court Decision. This statement applies when members recommend positions that depart from those determined in an administrative proceeding or court decision concerning the taxpayer's prior return. Administrative proceeding includes an examination by a taxing authority or an appeals conference relating to a return or a claim for refund. Court decision is one by any court within jurisdiction over tax matters.

When a tax return position is determined in an administrative proceeding or court decision, a member may still recommend a different position in a later year, unless the taxpayer is bound--such as by a formal closing agreement--to a specified treatment in the later year. The member may also prepare or sign a tax return that departs from that treatment.

The explanation to the statement says, "The consent in an earlier administrative proceeding and the existence of an unfavorable court decision are factors that the member should consider in evaluating whether the standards in SSTS no. 1 are met." Consequently, when the decision regarding the previous year is binding on the taxpayer, it may be the only position SSTS no. 1 supports.

SSTS no. 6, Knowledge of Error: Return Preparation. This statement outlines the standards when a member becomes aware of an error in a taxpayer's previously filed tax return or of a taxpayer's failure to file a required return. Error includes any position, omission or method of accounting that, at the time the return is filed, fails to meet the standards in SSTS no. 1. The term also includes a position taken on a prior year's return that no longer meets these standards due to legislation, judicial decisions or administrative pronouncements that apply retroactively. However, an item that has an insignificant effect on the taxpayer's tax liability is not an error.

A member should inform the taxpayer promptly upon becoming aware of an error in a previously filed return or of a taxpayer's failure to file a required return. He or she should recommend the corrective measures to take. The recommendation may be made orally. The member is not obligated to inform the taxing authority, and he or she may not do so without the taxpayer's permission, except when required by law.

If a member is asked to prepare the current year's return and the taxpayer has not corrected an error in a prior year's return, the member should consider whether to withdraw from preparing the return and whether to continue a professional or employment relationship with the taxpayer. If the member does prepare the current year's return, he or she should take reasonable steps to ensure the error is not repeated.

Both SSTS no. 6, paragraph 6, and SSTS no. 7, paragraph 7, describe filing an amended return as the mechanism for correcting an error. Members should consider whether alternative mechanisms are available. Most notably, in cases of erroneous accounting methods, a taxpayer may not be able to correct certain errors through amended returns, but rather must apply to the IRS for permission to change to another method (by filing Form 3115, Application for Change in Accounting Method).

SSTS no. 7, Knowledge of Error: Administrative Proceedings. What should a member do when he or she becomes 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? An error includes any position, omission or accounting method that, at the time the return is filed, fails to meet the standards in SSTS no. 1, It also includes a position on a prior year's return that no longer meets these standards due to legislation, judicial decisions or administrative pronouncements effective retroactively.

If a member is representing a taxpayer in an administrative proceeding involving a return with an error of which the member is aware, the member should inform the taxpayer promptly and recommend appropriate corrective measures. The recommendation may be made orally. A member is neither obligated to inform the taxing authority nor is the member allowed to do so without the taxpayer's permission, except where required by law.

A member should request the taxpayer's agreement to disclose the error to the taxing authority. Without it, the member should consider whether to withdraw from representing the taxpayer in the administrative proceeding and whether to continue a professional or employment relationship with the taxpayer.

SSTS no. 8, Form and Content of Advice to Taxpayers. This statement sets the standards for members providing advice to taxpayers. That advice does not have to be provided in any standard format; members should exercise professional judgment in deciding on what form advice should take. The statement also establishes that when subsequent developments affect earlier advice, the member is not obligated to inform the taxpayer except while helping a taxpayer implement procedures or plans associated with the advice or when a member undertakes this obligation by specific agreement.

TERMINOLOGY AND DEFINITIONS

As discussed earlier, several commentators asked for more definitions in the SSTSs. While a number of clarifications were added, in most cases the AICPA decided additional definitions were not appropriate.

Many of the terms for which commentators sought clarification are defined elsewhere or generally understood in tax practice. For example, it appeared that definitions of terms such as "reasonable effort" or "good-faith belief" were not necessary because, in general, tax practitioners should understand such terms to have the same meanings in ethical guidance as they have in the broader tax literature.

Also, ambiguity is not necessarily detrimental to members. Most tax practitioners readily appreciate that detailed definitions can create traps for the unwary. For example, would a more detailed definition or listing of the authorities that constitute "authority" under the "substantial authority" definition be in a member's best interest? Many practitioners find IRS field service advice (FSA) to be helpful, but these documents are not listed as "authorities" under Treasury regulations section 1.6662-4(d) (3)(iii). A more precise definition would therefore seem to preclude a member's argument that considering an FSA was reasonable.

"Consider" means "consider." Perhaps the single most controversial aspect of the SSTSs can be found in SSTS nos. 6 and 7. Both standards provide that if a taxpayer declines to correct an error, "the member should consider whether to withdraw from preparing the return and whether to continue a professional or employment relationship with the taxpayer." Some commentators believed "should consider" might be interpreted as an obligation to withdraw from the return preparation engagement, or even the larger relationship with the client.

After closely considering the text of both statements, it was decided that members should interpret the directive "should consider" as it is commonly understood. SSTS no. 6, paragraph 8, clearly supports this view by stating, "If the member does prepare such current year's return, the member should take reasonable steps to ensure that the error is not repeated." The standards simply do not say that the taxpayer must consent to the disclosure or withdraw. This language is part of the SSTSs' continuing role as an educational tool for members and information source for the public. The SSTSs provide guidelines that admonish members to inform taxpayers of errors and the opportunities to correct them--even when the member's conduct may have contributed to the error. The member clearly cannot inform the taxing authority of the error without the taxpayer's consent. At the same time, continued representation of the taxpayer is at best risky. Too many IRS agents tend to ask, "Are you aware of anything else that needs to be changed on the return?" That makes it prudent to assume that representing a taxpayer with a known error is problematic at best.

Duty to the system vs. duty to the taxpayer. Some questioned the statement in SSTS no. 1 that, "In addition to a duty to the taxpayer, a member has a duty to the tax system." This standard is essentially a continuation of a similar guideline in the SRTPs. It was concluded that the continued emphasis on broader responsibilities was appropriate. In addition, the recognition of such a duty is consistent with the professional ethics of the bar.

THE FUTURE

One of the objectives in revising the SRTPs into enforceable standards was to challenge the clarity of the existing SRTPs while preserving their proven framework. At the same time, both external events and the task force's close reexamination of the text of the SRTP's raised several issues that will be addressed in the future.

* Statement nos. 1 and 5 both address the preparation of tax returns, and Statement no. 5 can be viewed as applying standards in Statement no. 1 when a taxpayer was previously involved in a controversy over an item on a current year's tax return. Should these two statements be combined?

* Statement nos. 6 and 7 address a similar issue--handling an error discovered on a previously filed tax return--both in the context of preparing a subsequent return and representing the taxpayer. The SSTSs appear to set forth the same protocols for members to use in resolving both issues. Again, should these two statements be combined?

* Both government officials and tax practitioners have commented on a perception that the quality of tax opinions prepared by some practitioners has deteriorated, particularly in connection with corporate tax shelters. These criticisms may suggest a need to revisit the guidance provided to members concerning the preparation and content of tax opinions.

A GOOD FIT

Has anything changed for AICPA members who provide tax services? In general, the answer is no. While it's true the old SRTPs applied only to federal income tax practice and the SSTSs now apply to all tax engagements, most members already applied the highest standards of conduct in their tax practices, whether preparing a 1040 or representing a taxpayer in a local sales tax appeal hearing. Other than this broader applicability, the SSTSs mirror the SRTPs in both substance and framework and members should find they fit easily into their view of appropriate professional conduct.

State Rules for Tax Practitioners

A number of states incorporated the SRTPs as enforceable rules of conduct for CPAs licensed in their jurisdiction. In Colorado, for example, the rules provide in part that "a certificate holder, in the performance of tax services, shall conform to the professional standards applicable to such services. For purposes of this rule, such professional standards are considered to be defined by ... Statements on Responsibilities in Tax Practice ... by the AICPA."

At the end of 1998, Arizona, Colorado, Florida, Idaho, Kentucky, North Carolina, Tennessee and Washington had rules that could be interpreted as expressly adopting the SRTPs as enforceable standards for their licensees. In addition, Alabama, California, the District of Columbia, Maryland, Oklahoma, Pennsylvania, West Virginia and Wisconsin had rules that could be interpreted as implicitly adopting the SRTPs because they required licensees to conduct their practices in compliance with AICPA technical standards. Because each state used a slightly different formulation concerning the applicable standards for tax practice, the decision to include a state in one of the categories above is subjective.

EXECUTIVE SUMMARY

* THE AICPA HAS ISSUED EIGHT STATEMENTS on Standards for Tax Services as enforceable standards for AICPA members. Effective October 31, they replaced the advisory Statements on Responsibilities in Tax Practice.

* COMMENT LETTERS RAISED QUESTIONS ABOUT the necessity of enforceable tax practice standards. The strongest argument for enforceable standards is self-regulation--the profession is better served by self-regulation than by having third parties impose and enforce regulation.

* THE SSTSs WERE WRITTEN TO PROVIDE RELATIVELY subjective rules and leave certain terms undefined in some cases. As a result, an inadvertent or reasonable departure from an SSTS in certain situations would not result in loss of AICPA membership or other sanction.

* THE SSTSs WERE PUBLISHED IN THE OCTOBER 2000 Journal of Accountancy. They are also available on the Internet at www.aicpa.org/members/div/tax/intex.htm.

* ONE OF THE BIGGEST CONCERNS INVOLVES the use of the word "consider" in SSTS nos. 6 and 7 when members are considering withdrawing from preparing a return and whether to continue a professional or employment relationship with the taxpayer after discovering an error. The AICPA decided not to offer additional guidance, believing the explanations in the statement clarify that withdrawal is not mandatory.

J. EDWARD SWAILS, CPA, JD, is a principal with Ernst & Young in Washington, D.C. He is chair of the AICPA SRTP enforceability task force. His e-mail address is [e-mail].