Recognizing SRTP violations in return preparation.

The sweeping legislative changes of the past 11 years (e.g., the Tax Reform Act of 1986, Revenue Reconciliation Acts of 1990 and 1993, Small Business Job Protection Act of 1996 and Taxpayer Relief Act of 1997) have greatly increased the complexity of tax practice and the uncertainty faced by tax practitioners. Considering the many constituencies tax practitioners must serve (e.g., clients, the firm, the IRS, peers and the accounting profession), it is quite likely that a given CPA tax practitioner will face professional ethical conflicts (i.e., disagreement between mutually exclusive alternatives) in the course of a career. The most common response of AICPA members to the question, "What are the major ethical problems confronting AICPA members?" was "a client's proposal of tax alteration and/or tax fraud."(1) Tax-related malpractice suits are the number one cause of legal action against CPAs(2); this may have been caused by increased competition in the tax service arena, client pressure to minimize tax liability and/or ignorance or discounting of professional standards.(3) These factors may be the reason the Code's fines for practitioner violations have increased dramatically in number and size since 1985.(4) According to the AICPA, ethical behavior is a significant determinant of the quality of client and public service.(5)

Tax practitioners who are AICPA members may not recognize when behavior has violated the AICPA's Statements on Responsibilities in Tax Practice (SRTPs)(6); such practitioners may be unaware of the SRTPs (see Table 1 on page 655), may be aware of the SRTPs but not remember their content, or may discount the SRTPs in the decision-making process. Tax practitioners may need more education as to the SRTPs' content and scope to operate more ethically in this increasingly uncertain environment.

Table 1: The SRTPs

SRTP No. 1:       Tax Return Positions
INTRP. No. 1-1:   Realistic Possibility Standard
SRTP No. 2:       Answers to Questions on Returns
SRTP No. 3:       Certain Procedural Aspects of
                  Preparing Returns
SRTP No. 4:       Use of Estimates
SRTP No. 5:       Departure From a Position
                  Previously Concluded in an
                  Administrative Proceeding or Court
                  Decision
SRTP No. 6:       Knowledge of Error: Return
                  Preparation
SRTP No. 7:       Knowledge of Error: Administrative
                  Proceedings
SRTP No. 8:       Form and Content of Advice to
                  Clients

The SRTP's objectives are to:

* Recommend appropriate standards of responsibilities in tax practice and to promote their uniform application by CPAs.

* Encourage the development of increased understanding of the responsibilities of CPAs by the Treasury and IRS and to urge their officials to promote the application of commensurate standards of responsibilities by their personnel.

* Foster increased public understanding of, compliance with and confidence in our tax system through awareness of the recommended standards of responsibilities of CPAs in tax practice.

Currently, the SRTPs are unenforceable standards; compliance by CPA tax practitioners is voluntary. However, many states (e.g., Arizona, Colorado, Florida, Idaho, Kentucky, North Carolina and Washington) treat them as enforceable via state statute or regulation.(7) The SRTPs undergo a continual process of review and revision that recognizes the dynamic nature of the tax practitioners' environment and the significance of tax practice to CPAs.

For the SRTPs to be useful, a CPA tax practitioner first must recognize when a situation contains professional ethical issues. The failure to behave ethically is most often due to the inability to identify such issues.(8) Without ethical recognition, the first phase of the ethical decision-making process does not occur, and a CPA tax practitioner's options will be drastically reduced.

Ethical Recognition Examples

The following examples test the ability to recognize conduct contrary to the SRTPs. A discussion of the applicable SRTPs follows each example. The SRTPs do not attempt to address every situation and do not always offer absolute guidance. Table 2 on page 656 offers other SRTP guidance not addressed in the examples.

Table 2: Other Ethical Considerations

SRTP 2.04: "Reasonable grounds may exist for omitting an answer [to a question on a return.] For example, reasonable grounds may include the following: (a) the 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... (b) genuine uncertainty regarding the meaning of the question...(c) the answer to the question is voluminous and assurance should be given on the return that the data will be supplied upon examination."

SRTP 3.04: "The individual CPA...should consider information actually known to that CPA from the tax return of another client when preparing a tax return if the information is relevant to that tax return...and use of such information does not violate any law or rule relating to confidentiality."

SRTP 8.04: "The CPA may choose to communicate with a client when subsequent developments affect advice previously provided with respect to significant matters. However, the CPA cannot be expected to have assumed responsibility for initiating such communication except while assisting a client in implementing procedures or plans associated with the advice provided or when the CPA undertakes this obligation by specific agreement with the client."

Example 1: C, a CPA tax practitioner with XYZ & Co., is responsible for the tax work of P, a new and important client. The amount P indicated for 1996 charitable contributions is larger than P's prior three years' reported contribution deductions. P advised C that P misplaced the documentation pertaining to the 1996 charitable contributions. C enters the charitable contributions on P's 1996 tax return and decides to use the remaining budgeted hours to pursue and verify more material amounts and issues.

The following SRTPs apply:

SRTP 3.02: "In preparing or signing a return, the CPA may in good faith rely without verification upon information furnished by the client or by third parties. However, the CPA should not ignore the implications of information furnished and should make reasonable inquiries if the information furnished appears to be incorrect, incomplete, or inconsistent either on its face or on the basis of other facts known to the CPA. In this connection, the CPA should refer to the client's returns for prior years whenever feasible."

SRTP 3.03: "Where the Internal Revenue Code or income tax regulations impose a condition to deductibility or other tax treatment of an item (such as...substantiating documentation), the CPA should make appropriate inquiries to determine to his or her satisfaction whether such condition has been met."

SRTP 4.02: "A CPA may prepare tax returns involving the use of the taxpayer's estimates if it is impracticable to obtain exact data and the estimated amounts are reasonable under the facts and circumstances known to the CPA. When the taxpayer's estimates are used, they should be presented in such a manner as to avoid the implication of greater accuracy than exists."

Conclusion: The contribution information C was given is incomplete; the charitable deduction has increased in comparison to that on prior-year returns. According to Circular 2309 Section 10.22, the CPA tax practitioner has an obligation to exercise due diligence in preparing and filing tax returns. However, the client has the ultimate responsibility for the return's contents. It may not be impracticable for C to request P to obtain replacement documentation from the donees.

Other issues: Should C receive a written statement from P detailing the contributions and the reasons for the missing documentation? Does it matter whether the current increase in the deduction is material? Should C inform P of any penalties that may apply? Does the fact that P is a new and important client carry undue weight with C? Should C document conversations with P about this issue? What other file information is needed? Is C exhibiting willful and reckless conduct (i.e., Sec. 6694(b))? Should C contact the donees for evidence of receipt? How much time should be expended on this issue overall?

Example 2: C recently found out that an error was made in P's tax return (in P's favor) three years ago, prior to P becoming an XYZ & Co. client. The error was made by P's former tax firm. C calculates the extra tax burden and determines that the additional tax liability is small. C's supervisor agrees as to the magnitude of the additional tax liability and supports C's decision not to expend any more resources on this situation. C moves on to other issues with XYZ & Co.'s full support.

The following SRTPs apply:

SRTP 6.03: "The CPA should inform the client promptly upon becoming aware of an error in a previously filed return...."

SRTP 6.01: "[E]rror does not include an item that has an insignificant effect on the client's tax liability...."

SRTP 6.07: "Whether an error has no more than an insignificant effect on the client's tax liability is left to the judgment of the individual CPA based on all the facts and circumstances known to the CPA."

Conclusion: It does not matter, according to SRTP No. 6, that C did not cause the error. C should inform P of the error; the determination of the error's effect on tax liability is left to C's professional judgment.

Other issues: The statute of limitations is generally three years, according to Sec. 6501(a) and (b)(1). SRTP No. 6 does not distinguish based on when the error occurred. If the error was caused by fraud or an omission of gross income exceeding 25%, a longer statute of limitations would apply. Does it matter that XYZ & Co. signed off on the significance issue?

Example 3: P is always reading about tax planning strategies and putting excessive pressure on XYZ & Co. to reduce his tax liability. P proposes to C a tax-cutting idea from an article by a tax practitioner in Q, a weekly business periodical, and engages C to research the idea. C knows from experience that the IRS examines this tax issue very infrequently (i.e., the likelihood of detection is small), but has been known to take the opposite position when aware of the issue. The few court cases involving this issue do not support the taxpayer's position. However, the Q article contains pro-taxpayer support. C decides that P's position is valid, and C's supervisor agrees. C also reasons that P's return is not likely to be audited; however, if it is, this issue would serve as a good bargaining position in a settlement negotiation.

The following SRTPs apply:

SRTP 1.03a: "The CPA should not recommend a tax return position that...[e]xploits the Internal Revenue Service audit selection process...."

Conclusion: A CPA tax practitioner must determine whether "exploits" means that the audit selection process is the only decision criterion used or just one of several major criteria. Here, the selection process may have been the dominant, but not the only, criterion used.

SRTP 1.03b: "The CPA should not recommend a tax return position that...serves as a mere `arguing' position advanced solely to obtain leverage in the bargaining process of settlement negotiation with the Internal Revenue Service."

Conclusion: SRTP No. 1 stresses that the tax position may not serve solely to obtain leverage in a negotiation. Here, it appears that this is just a portion of the rationale used to accept the tax position.

Other issues: Could C be subject to Sec. 6701(a), which imposes a civil penalty on any person who aids or advises in the preparation of a return, if the item is material and will cause an understatement of tax liability?

SRTP 1.02a: "A CPA should not recommend to a client that a position be taken with respect to the tax treatment of any item on a return unless the CPA has a good faith belief that the position has a realistic possibility of being sustained administratively or judicially on its merits if challenged."

INTRP. 1-1.02: "If a CPA concludes that a tax return position does not meet the realistic possibility standard, the CPA may still recommend the position to the client or, if the position is not frivolous and is adequately disclosed on the tax return or claim for refund, the CPA may prepare and sign a return containing the position."

INTRP. 1-1.03: "A frivolous position is one which is knowingly advanced in bad faith and is patently improper."

INTRP. 1-1.07: "In determining whether a tax return position meets the realistic possibility standard, a CPA may rely on authorities in addition to those evaluated when determining whether substantial authority exists. Accordingly, CPAs may rely on...articles in recognized professional tax publications...."

INTRP. 1-1.08: "In determining whether a realistic possibility exists, the CPA should do all of the following. a. Establish relevant background facts. b. Distill the appropriate questions from those facts. c. Search for authoritative answers to those questions. d. Resolve the questions by weighing the authorities uncovered by that search. e. Arrive at a conclusion supported by the authorities."

Conclusion: According to the SRTPS, the realistic possibility standard cannot be quantified. However, Circular 230 and Sec. 6694(a) require that the tax position have at least a "realistic possibility" (i.e., a greater-than-33% chance of success) to avoid a preparer penalty. A taxpayer may need to have "substantial authority" (i.e., a greater-than-50% chance of success), a level of accuracy higher than a realistic possibility. Conflicts between the practitioner and client could arise because of these differing levels of assurance; the Q article may be authority for SRTP, but not for Circular 230 and Sec. 6694(a), purposes.

Other issues: Should a practitioner be assured the higher success level exists before asserting a position, in light of the potential penalties? It appears that the tax position here may not have a realistic possibility of success, much less substantial authority. Should disclosure on Form 8275, Disclosure Statement, be made of the tax position to avoid the practitioner penalty? If disclosure is made, should it matter that a red flag is then raised that may increase the probability of an audit? How much credibility should C give the Q article? Is the article in a recognized professional publication? Did C advance the position due to P's persistence or his status as a new and lucrative client? Might P refer XYZ & Co. to others if C follows P's wishes? Should that matter? Does XYZ & Co.'s signing off on the position preclude C from having acted in bad faith?

Example 4: C has completed P's 1996 tax returns and discussed the results with P and his XYZ & Co. supervisor. The returns are mailed. Several weeks later, C's supervisor is perusing P's completed return and discovers an overlooked issue. C's error gave P a tax savings. C's supervisor strongly recommends, and C agrees, not to amend the return. The overlooked issue affects numerous schedules in P's return that would be time-consuming and costly to redo. Also, P's confidence in XYZ & Co. might be reduced.

The following SRTPs apply:

SRTP 6.03: "The CPA should inform the client promptly upon becoming aware of an error in a previously filed return...The CPA is not obligated to inform the Internal Revenue Service, and the CPA may not do so without the client's permission...."

SRTP 6.05: "... It is the client's responsibility to decide whether to correct the error."

SRTP 6.07: "Whether an error has no more than an insignificant effect on the client's tax liability is left to the judgment of the individual CPA based on all the facts and circumstances known to the CPA."

Conclusion: C's signing the return does not violate the spirit of SRTP No. 6 if C did not know of the error when he prepared the return. However, if C intentionally did not address the issue, he has violated not only the SRTPs, but potentially Sec. 7206(2), the criminal penalty of aiding or assisting in the preparation or presentation of a false return, or Sec. 6694(b), the civil penalty of willful attempt to understate tax liability. To help alleviate the potential penalties, SRTP 6.03 suggests that C inform P of the error and not to inform the IRS unless P consents. According to the SRTP, it is P's responsibility to decide whether to correct the error.

Lack of Recognition of Ethical issues

Causes

The failure to recognize professional ethical issues has a number of possible causes. CPA tax practitioners may be unaware that the SRTPs exist, may not remember their content or may ignore them due to lack of enforceability. In addition, if CPA tax practitioners do not fully identify with the profession's goals and values, recommendations made by the profession may not be taken seriously or may carry little weight.

Solutions

If CPA tax practitioners are not sensitive to the issues in the SRTPs, the SRTPs' primary objectives are not achieved. If CPA tax practitioners are not uniformly applying the SRTPs' standards, the public's confidence in our tax system decreases. A new approach needs to be taken to increase compliance with the SRTPs (i.e., increased education and/or enforceability). Each alternative has extensive, quantifiable costs, but the immeasurable benefit of creating more ethical tax practitioners is crucial to maintaining the public's confidence in CPA tax practitioners.

The National Association of State Boards of Accountancy may want to consider mandatory ethics continuing professional education courses for CPAs to maintain their licenses. The AICPA's recommended 150-hour accounting curriculum advocates an ethics course that signals the importance of ethics training for accounting students.(10) Educating CPA tax practitioners by increasing their exposure to the SRTPs may enhance the potential personal and professional benefits of adherence to the SRTPs' standards. The AICPA may well want to make the SRTPs enforceable, similar to its General Code of Conduct. The possibility of sanctions and penalties may cause some CPA tax practitioners to become more responsive to the standards promoted by the SRTPs.

Conclusion

While the SRTPs are offered as guidance to the CPA tax practitioner, in many instances, professional judgment is still required. The SRTPs are not all-encompassing and not intended to give absolute direction in every situation with ethical content; rather, the SRTPs are a tool to be used in a CPA tax practitioner's decision-making process, along with other pertinent information (i.e., the Code, AICPA's General Code of Conduct, Circular 230, professional judgment, firm's code of conduct, etc.). The examples in this article are intentionally general to allow the reader to process through the largest possible range of alternatives. The pertinent sections of the SRTPs and corresponding discussions that followed each example were meant as guidance and, in most cases, not definitive answers. Hopefully, this article will allow a CPA tax practitioner to become more aware of and more sensitive and better able to recognize ethical content in tax situations.

(1) See Finn, Chonko and Hunt, "Ethical Problems in Public Accounting: The View from the Top," 7 Journal of Business Ethics 605 (Aug. 1988), p. 607.

(2) See Fisher, "How to Handle Your Accountant," 123 Fortune 117 (2/25/91), p. 117.

(3) See Fisher, "Finding the Right Tax Advisor," 129 Fortune 159 (3/21/94), p. 159.

(4) See CCH Tax Advisory Board Roundtable, "The Changing Practice of Tax Law for Lawyers and Accountants," 72 Taxes 190 (April 1994), p. 192.

(5) Beets and Killough, "The Effectiveness of a Complaint-Based Ethics Enforcement System," 9 Journal of Business Ethics 115 (Feb. 1990), p. 118.

(6) AICPA Federal Taxation Executive Committee, Statements on Responsibilities in Tax Practice (SRTPs) (1991 rev.).

(7) See D.C. Currents, "Tax Practitioners Face Heightened Litigation and Traps for the Unwary," 27 The Tax Adviser 501 (Aug. 1996), p. 502.

(8) See, e.g., Bok, "Can Ethics be Taught?," 22 Change 26 (Oct. 1976), p. 28; Hunt and Vitell, "A General Theory of Marketing Ethics," 6 Journal of Macromarketing 5 (Spring 1986), p. 7; Trevino, "Ethical Decision Making in Organizations," 11 Academy of Management Review 601 (Summer 1986), p. 602.

(9) Circular 230, Regulations Governing the Practice of Attorneys, Certified Public Accountants, Enrolled Agents, Enrolled Actuaries and Appraisers Before the Internal Revenue Service.

(10) See Langenderfer and Rockness, "Integrating Ethics into the Accounting Curriculum," 4 Issues in Accounting Education 58 (Spring 1989), p. 60; see also Hermanson and Carcello, "An Analysis of Current Accounting Programs in the Context of the Anderson, Treadway and Bedford Reports," 7 Journal of Accounting Education 93 (Spring 1989), p. 94; Nelson, "An Update on the 150-Hour Educational Requirement," 9 Journal of Accounting Education 53 (Spring 1991), p. 60; Smith and Usry, "Changes in Accounting Education," 7 Journal of Accounting Education 1 (Spring 1989), p. 2.

EXECUTIVE SUMMARY

* Ethical behavior is a significant determinant of the quality of client and public service.

* CPA tax practitioners may be unaware that the SRTPs, exist, may not remember their content, may ignore them due to lack of enforceability, or may not fully identify with the profession's goals and values.

* The increase in tax-related malpractice suits may be caused by increased competition in the tax service arena, client pressure to minimize tax liability and/or ignorance or discounting of professional standards.