Recent guidance under Circular 230 raises questions for signing preparers.

The Office of the Director of Practice (ODP) recently published scenarios of conduct that may result in discipline under Circular 230. Although the guidance is helpful, it raises important questions about the relationship between the "due diligence" and return preparation standards for signing preparers under Sections 10.22(a) and 10.34 of Circular 230, respectively, as well as about the ODP's understanding of the substantiation requirements for return positions.

Circular 230 governs the practice of CPAs, attorneys, enrolled agents and enrolled actuaries ("practitioners") before the Treasury, including the IRS. Circular 230 is especially significant because the sanctions for violating it can be severe. These include suspension or disbarment from practice before the Service. "Practice before the Service" is a broad concept, encompassing most aspects of Federal tax practice.

Scenarios of Practitioner Misconduct

The ODP guidance consists of four scenarios or examples of practitioner: conduct that, according to the ODP, violated one or more of the provisions of Circular 230. Although this guidance is not technically precedent, it is a useful indicator of the ODP's views The scenarios represent composites of actual fact patterns that have come to the attention of that office.

In the first example, a practitioner was considered to have knowingly made a false statement on the taxpayer's return in violation of Section 10.51(b) by improperly deducting a physician's commuting expenses. In the second example, a practitioner was considered to have engaged in contemptuous conduct in violation of Section 10.51(i) by losing his temper and shouting abusive language at a revenue officer. In the third example, practitioner was considered to have violated Section 10.22(a) by signing a return as a preparer that improperly treated personal trips as business trips. In the fourth example, a practitioner was considered to have violated Section 10.21 by failing to inform his client that there was an error in the filing status checked on the client's previously filed return. The Relationship Between Section 10.22(a) and Section 10.34 Although the ODP has issued scenarios of practitioner misconduct in the past, this is the first set of examples that raises questions about the relationship between the "due diligence" standard for tax practitioners in Section 10.22(a) of Circular 230 and the relatively recent (1994) return preparation standards in Section 10.34. According to the due diligence standard in Section 10.22(a), a practitioner must exercise due diligence in preparing or assisting in the preparation of returns or other documents relating to IRS matters. According to the return preparation standards in Section 10.34(a), a practitioner (among other things) may not sign a return as a preparer if the practitioner determines that the return contains a position that lacks a realistic possibility (i.e., a one-in-three chance) of being sustained on its merits, unless the position is not frivolous and is adequately disclosed to the Service. Under Section 10.34(b), a practitioner may not be disciplined for violating Section 10.34(a) unless the violation was willful, reckless or a result of gross incompetence. This special disciplinary standard for Section 10.34 violations reflects Treasury's and Congress's concern that discipline under Circular 230 not be imposed too routinely for inaccurate return positions.

It is important to have an understanding of which cases are subject to the due diligence standards and which are subject to the return preparation standards, because it appears to be easier to violate the former standards than the latter. This is largely because the term "due diligence" is vague and any lack of due diligence" could trigger discipline under Section 10.22(a). By contrast, regardless of the imprecision inherent in the return preparation standards in Section 10.34(a), only a willful, reckless or grossly incompetent violation would satisfy the disciplinary thresholds under Section 10.34(b). Thus, if cases potentially subject to both sets of rules are viewed as governed by the due diligence standards, the return preparation standards (and their policy underpinnings) could be undermined. In addition, favoring a due diligence analysis could increase the number of cases in which discipline is imposed by the ODP.

This uncertain interplay between the two sets of standards in the context of signing preparers is perhaps best illustrated by the third example in the recently published set of scenarios (i.e., the example that treats a signing preparer as having violated Section 10.22(a) because the taxpayer's return improperly treated personal trips as business trips). In this example, the practitioner's employee completed a client's tax return, which the practitioner reviewed and signed as a preparer. According to the example, the employee accepted the client's characterization of several trips as business trips. The employee also did not make further inquiry or request substantiation, even though the firm's policy was to obtain substantiation for business trips. It turned out that no business purpose for the trips could be substantiated.

The ODP concluded that the practitioner did not knowingly submit false information (in view of the office's substantiation policy and its history of compliance), but "could not disclaim responsibility for the tax return's accuracy" and, therefore, was considered to have violated Section 10.22(a). Presumably, the signing preparer would not have violated Section 10.34. It is unlikely, based on these facts, that the preparer would have been found to have determined that the position lacked a realistic possibility of success. In any event, he did not act willfully, recklessly or with gross incompetence.

The ODP's Views on Substantiation Requirements

Perhaps the ODP intends to analyze lack of substantiation cases under the due diligence rules, rather than the return preparation rules. Regardless of whether this is an acceptable approach, it would be helpful to practitioners if future guidance in the substantiation area reflected a clearer application of relevant law. Given the format of the ODP guidance (a nonprecedential set of actual fact patterns with conclusions), it is understandable that the guidance does not contain lengthy legal analysis. Nevertheless, the examples would be more useful to practitioners if the examples identified more clearly the facts central to their conclusions.

For example, scenarios one and three state that the practitioner did not request substantiation of the questioned positions. It is clear from applicable law, however, that return preparers generally are not required to request substantiation. Section 10.34(a)(3) provides that a practitioner generally may rely on information furnished by a client unless the practitioner has reason to believe the information is incorrect, inconsistent or incomplete. In addition, Regs. Sec. 1.6694-1(e) (from which Section 10.34(a)(3) was drawn) makes clear that a preparer generally is not required to ask for underlying documentation, although he should inquire whether it exists.

From Evelyn Elgin, J.D., LL.M., Washington, D.C.