The tax practitioner's guide to Circular 230.

The first part of this article, in the November issue, addressed practice, solicitation, and fee issues under Treasury Department Circular 230 (Circular 230), due diligence and the Sec. 6694 realistic possibility standard. This part discusses disreputable conduct under Circular 230, other Circular 230 rules of practice and referrals to the IRS Director of Practice (Director).

Disreputable Conduct

Attorneys, CPAs and enrolled agents who engage in "disreputable conduct" may be suspended or disbarred from practice before the IRS. Although Circular 230 does not define disreputable conduct, Section 10.51(a)-(j) provides a nonexclusive list of examples of disreputable conduct likely to result in disbarment or suspension.(38) Section 10.51(j), which relates to false opinions, was the only form of disreputable conduct modified by the 1994 amendments to Circular 230. Section 10.51(j), added to Circular 230 in 1984 to enable the IRS to enforce the regulations on tax shelter opinions in Section 10.33, prohibits giving false opinions knowingly, recklessly or through gross incompetence, or through a pattern of providing incompetent opinions on questions arising under the Federal tax laws. Even the IRS is unclear whether Section 10.51(j) is limited to tax shelter opinions or whether it may apply to other tax-related opinions.(39)

After identifying several types of false opinions, Section 10.51(j) defines both reckless conduct and gross incompetence; reckless conduct is defined as "a highly unreasonable omission or misrepresentation involving an extreme departure from the standards of ordinary care that a practitioner should observe under the circumstances."(40) Thus, the definition of reckless conduct for Section 10.51(j) purposes appears to be limited to giving false opinions.

In contrast, the definition of gross incompetence was not modified by the 1994 amendments, nor was its application limited to the giving of false tax shelter opinions. "Gross incompetence" is conduct that reflects gross indifference, preparation grossly inadequate under the circumstances, or a consistent failure to perform obligations to the client. In ascertaining whether a practitioner has violated Section 10.51(j) knowingly, recklessly or through gross incompetence, the Service will take into account a practitioner's pattern of conduct.

A Section 10.51(a) criminal conviction for violation of the Federal revenue laws, as well as any offense involving dishonesty or breach of trust, is also disreputable conduct for Circular 230 purposes. So is the suspension or disbarment of an attorney, CPA, public accountant or actuary from practice by a state authority or Federal court, agency, board or other Federal body. Such a suspension or disbarment triggers Section 10.51(g),(41) and typically results in a consent suspension from further practice before the Service.(42)

* Failure to file or pay

A practitioner who fails to file his, or a client's, tax return by the due date may violate Section 10.51(d). Because the IRS assumes that all practitioners are aware of filing requirements, a failure to file is presumed to be willful.(43) However, whether a practitioner's nonfiling is evidence of egregious misconduct under Section 10.51 sufficient to justify suspension or disbarment from practice depends on the facts and circumstances. When nonfiling results in a reprimand rather than a suspension or disbarment, the IRS monitors the practitioner's filing of required returns for five years and warns him that further nonfiling will result in more severe sanctions.

The IRS will respond to inquiries from law and accounting firms seeking verification that their associates or employees have filed all required returns. Fact-of-filing information requests are made on Form 8821, Tax Information Authorization, and require the employee's consent. Firms may view this step as necessary to verify that an employee's disreputable conduct under Section 10.51(d) does not taint the firm, because a firm that practices before the IRS cannot employ anyone under suspension or disbarment.(44)

A willful failure to pay income or employment taxes also constitutes disreputable conduct in violation of Section 10.51(d). To establish a willful failure to pay, the Director must demonstrate that the practitioner had both the duty and the resources to pay the taxes.(45) In addition, Section 10.51(d) prohibits other forms of tax evasion, including any attempt to evade Federal taxes, knowingly counseling to a client or prospective client an illegal plan to evade such taxes or concealing assets to evade such taxes. Thus, CPAs who give taxpayers advice on how to evade taxes violate this provision, even if they neither prepare the return nor represent the taxpayer. Likewise, CPAs who counsel their clients to take a nondisclosed aggressive return position that would not meet the realistic possibility of success standard have participated in a plan to avoid taxes in violation of Section 10.51(d).(46)

* Providing misleading or false information

Although providing misleading or false information to the IRS may violate Section 10.51(d) if it is part of a plan to avoid payment of taxes, the giving of such information may also violate Section 10.51(b). Similarly, a practitioner who knowingly omits income from a return may violate both Section 10.51(b) and (d). According to the IRS, providing false information on income tax returns is the most common basis for a Section 10. 5 1 (b) referral to the Director. In addition, any false or misleading information given in testimony, Federal tax returns, financial statements, applications for enrollment, affidavits, declarations, or any other document or statement, written or oral, in connection with any tax matter pending before the Service or a tribunal authorized to pass on Federal tax matters, may violate Section 10.51(b), even if there are no tax consequences.(47)

To violate Section 10.51(d), the practitioner must know that the information provided to a person or entity specified in that section is false or misleading.(48) Even correct information may be violative if provided in a misleading manner. For example, during an IRS examination of a taxpayer's return at the practitioner's office, the CPA advises his client to prepare a record of mileage expenses using different pens so that it will appear that the log was prepared in the year under examination. The Director's position is that the CPA has violated Section 10.51(b), whether or not the information in the log is correct, because it is misleading as to its time of preparation.(49)

Other Rules of Practice

Section 10.20 governs the furnishing of information to the IRS and the Director. Under Section 10.20(a), no practitioner can neglect or refuse promptly to submit, or interfere with or attempt to interfere with any lawful and proper request for information or records by any duly authorized Service employee or officer, unless the practitioner believes on reasonable grounds and in good faith that such information or record is privileged or that the request for, or effort to obtain, such record or information is of doubtful legality. Section 10.20(a) is violated only when the IRS records request is accompanied by a summons; there is no violation as to records not covered by the summons. In addition, if a practitioner has promised to furnish certain records or information and subsequently does not furnish them, a violation of Section 10.20(a) may have occurred.(50) CPAs who receive a summons or other request for records should talk with their clients and may also wish to consult a tax attorney.

Section 10.21 applies when a practitioner knows of a client's omissions or errors.(51) A practitioner who knows that a client is not in compliance with Federal revenue laws or who has made an omission or error on any document, return, affidavit or other paper must promptly advise the client about such omission, error or other lack of compliance. A literal reading of Section 10.21 does not require the practitioner to suggest a way to correct the problem, only to inform the client. However, the IRS believes that the practitioner is required to tell the client of the error and recommend corrective action.(52) Likewise, AICPA Statements of Responsibilities in Tax Practice (SRTPs) No. 6, Knowledge of Error: Return Preparation (1991 rev.), and SRTP No. 7, Knowledge of Error: Administrative Proceedings (1991 rev.), suggest that CPAs knowing of a client error on a return or in an administrative proceeding should inform the client about it and suggest ways to correct it.(53) Circular 230 does not require the CPA to inform the Service about the error or omission; SRTPs Nos. 6 and 7 add that a CPA is neither obligated to inform the Service nor may the CPA do so without the client's permission, except where required by law.(54) However, because the Director considers the SRTPs to be enforceable as part of the professional conduct standards for CPA tax practitioners,(55) a CPA should consider whether to withdraw from representing anyone who will not inform the Service about an error or correct it. In deciding whether to continue a professional relationship with the client, the CPA should consider factors such as client confidentiality under AICPA Rule of Conduct 301, Client Confidential Information, and state law(56); a tax attorney may need to be consulted.

Section 10.23 prohibits CPAs from unreasonably delaying the prompt disposition of any matter before the Service. Unreasonable delays in providing documents that the practitioner has agreed to give to an IRS employee or officer may violate that section, due diligence in Section 10.20, or the error and omissions provisions in Section 10.22(b). Failure to respond to correspondence or phone calls, lack of preparation by the practitioner for IRS meetings, habitual lateness or last-minute cancellations of meetings with IRS personnel, or other patterns of delay may also constitute unreasonable delay under Section 10.23. The Service regards unreasonable delay of an examination as cause to ignore a power of attorney that justifies directly contacting the taxpayer.

Potential conflicts of interest are addressed in Section 10.29, which provides that no practitioner can represent conflicting interests in practice before the Service, except by express consent of all directly interested parties after full disclosure. Common conflicts might involve representing more than one party before the Service in the same or related cases or taking inconsistent positions that might benefit one client while harming the interests of another. It is probably best to avoid all conflicts of interest; as one source has stressed, "if a potential conflict exists and the explanation of the conflicts and consequences takes more than one page [of explanation], don't represent more than one client."(57) Most commentators agree that a practitioner should research all potential conflicts of interest and notify all parties potentially in conflict. A written explanation of potential or actual conflicting interests, while not mandated by Section 10.29, should be provided to clients, signed by all parties and maintained in a firm's files, as client memories of an oral explanation may be vague and confused.(58) Because neither the AICPA Tax Division nor the AICPA Ethics Division has yet issued comprehensive guidance on conflicting interests, practitioners should consult available ethical pronouncements issued by the legal profession.(59)

Referrals to the Director

Referrals to the Director are made by Service personnel and any other parties who believe that the provisions of Circular 230 may have been violated. A referral will lead to the Office of the Director taking no action, issuing a private reprimand letter, or suspending or disbarring the practitioner from practice before the Service. Thus, it is imperative that a practitioner be very careful before agreeing simply to pay a penalty as part of the cost of doing business, as even a minor penalty may result in a referral to the Director. Because the IRS maintains files on referred practitioners, a few minor penalties may be regarded as sufficient to establish a pattern of misconduct that justifies stronger sanctions.

Circular 230 regulates the employment of former IRS agents, as well as disbarred or suspended practitioners. Section 10.24 states that a practitioner may not knowingly, directly or indirectly, accept assistance from or employ any person suspended or disbarred from practice before the Service; nor may a practitioner accept employment as a subagent, correspondent or associate, or share fees with any disbarred or suspended person similarly prohibited from practicing before the Service.

Moreover, maintaining a partnership for the practice of law, accountancy, or other related professional service with a person under disbarment from practice is presumed to be a violation of Section 10.51(h). Although no similar restriction applies to maintaining a partnership with an individual who is suspended, Section 10.51(h) defines as disreputable conduct knowingly aiding and abetting another person to practice during a period of suspension, disbarment or ineligibility. This provision is buttressed by Section 10.24, which, as discussed previously, covers assistance from suspended or disbarred persons. Obviously, these two provisions could make it difficult for one to maintain employment or partnership arrangements.

Conclusion

The Treasury and IRS have increasingly tried to make practitioners into quasi-IRS agents. Although CPAs have a legal responsibility to operate within the law, they also have both the right and responsibility to be a client advocate, and a taxpayer has no obligation to pay more taxes than are legally required.(60) Thus, CPAs must continue to aggressively, but legally, represent their clients.

To continue to represent clients effectively, practitioners should take prudent steps to ensure compliance with Circular 230. The majority of referrals to the Director come under the preparer penalty rules or under Section 10.53. Although most of the actual suspensions or disbarments are for egregious conduct, many practitioners are ignorant of Circular 230's content and do not realize that it imposes additional responsibilities on CPAs. Violations of Circular 230 can range from due diligence to advertising. Even if a referral leads to a no action or to a reprimand letter, the practitioner's name is on file and he may have incurred significant legal expenses. Thus, to reduce the likelihood of a referral, at a minimum, practitioners should do the following:

[] Document all client communications (e.g., tax planning advice and warnings to clients about possible Sec. 6662 accuracy-related penalties).

[] Discuss with clients penalty avoidance through disclosure on Forms 8275, Disclosure Statement, or 8275R, Regulation Disclosure Statement (or on the return, when appropriate).

[] Conduct regular continuing education classes about professional ethics so that staff are informed regarding tax practice responsibilities under the SRTPs, Circular 230 and the preparer penalty rules.

[] Consult with a tax attorney if a preparer penalty is proposed during an examination, because the penalty may lead to a referral to the Director.

[] Ensure that all returns are properly reviewed, that clients are aware that returns are their responsibility and that aggressive return positions are based on primary authority.

[] Assess the "riskiness" of new and continuing clients (especially if they complain about the IRS or do not keep adequate books and records).

Preparers operate in a very challenging environment and are still called upon to provide excellent tax services at a competitive cost. Ignorance of tax practice responsibility standards such as Circular 230 can lead to sanctions and to severe economic consequences. Knowledge of one's professional and ethical responsibilities can prevent referrals under Circular 230 and help reduce extended legal disputes with the Service.

(38) See Referrals to the Director of Practice, Coursebook (Training 9994-102) (IRS, Dec. 1992), p. 4-4 (hereinafter, "Coursebook"). While a conviction for drug trafficking would constitute disreputable conduct under Section 10.51 (see pp. 4-8 and 4-16), if the conviction is for a crime less related to a governmental interest or to practice before the IRS (e.g., a sex crime), a finding of disreputable conduct is less clear. Nevertheless, referral to the Director is recommended, who will make an appropriate disposition; see p. 4-16. (39) See id., p. 4-16; Jones, Keller and Mares, Guide to Dealing with the IRS (Practitioners Publishing Company, 2d ed., 1994), p. 20-14 (hereinafter, "Guide"). See also Cogdell, "Practice Before the IRS and Circular 230," 147-5th T.M., p. A-45. (40) Prior to 1994, Section 10.51(j) defined reckless conduct as "more than merely simple or inexcusable negligence." According to the explanation of changes issued by the Treasury to accompany T.D. 8545 (6/15/94), the omission of a reference to a negligence standard has no substantive significance. The new definition also substituted "should observe under the circumstances" for the prior language "is either known or is so obvious that the competent practitioner must or should have been aware of it." Similarly, the Treasury has announced that these changes were intended to streamline the definition of reckless conduct without changing its substance. (41) However, not all suspensions under state law constitute disreputable conduct under Section 10.51, and are not grounds for suspension or disbarment from practice before the IRS. For example, an attorney suspended by the state bar association for failing to pay dues has not engaged in disreputable conduct. See Coursebook, note 38, p. 4-13, Example 5. (42) Id., p. 4-5. (43) See, e.g., Joseph W Poole, DC D.C., 1984 (54 AFTR2d 84-5536, 84-2 USTC 19612) (upholding the Treasury's suspension of a CPA under Section 10.51(d) for willfully failing to file his own returns for three years). (44) See Guide, note 39, p. 20-14, and Salchow, IRS Practice and Policy (Tax Management, Inc., 1990), vol 2., 91120.D.4, which discuss the Nonfiler Initiative program adopted in Ann. 93-36, IRB 1993-10, 66; see also Ann. 95-41, IRB 1995-21, 20. Similar tainting can also occur from maintaining a partnership with a person who has been disbarred from practice before the IRS, as such conduct is presumed to be disreputable in violation of Section 10.51(h). (45) Coursebook, note 38, p. 4-9. The IRS's position is that a practitioner who fails to pay employment taxes for more than one quarter should be referred to the Director. In evaluating the practitioner's ability to pay employment taxes, referrals should specify the number and identities of employees, as well as the practitioner's relationship to them, particularly when smaller and/or family-operated firms are involved. (46) Id., p. 4-11. (47) See id. The IRS notes at id., p. 4-14, however, that the existence of a revenue loss may affect the severity of the sanctions imposed on the practitioner. The presence of tax consequences may also give rise to a finding of disreputable conduct under Section 10.51(d) for tax evasion. (48) The Director can establish the knowledge element by demonstrating that the practitioner should have known that the information provided was false or misleading; see id., p. 4-11. (49) Id., p. 4-12. (50) Id., p. 4-17. Section 10.20(b) requires any CPA who practices before the Service, when requested by the Director, to provide any information he may have concerning violations of the regulations and to testify in any proceedings instituted for disbarment or suspension. (51) See Wolfman, Holden and Harris, Standards of Tax Practice (Little, Brown & Co., 3d ed., 1995) (hereinafter, "Standards"), [sections]207.4.2, for a discussion of a taxpayer's legal obligation to amend returns. See also Ernest Badaracco, Jr., 464 US 386 (1984)(53 AFTR2d 84-3446, 84-1 USTC [paragraph]9150). (52) Coursebook, note 38, p. 4-23. (53) See SRTPs Nos. 6 and 7; both broadly define "error" to include any position, omission or method of accounting that at the time the return is filed fails to meet the standards set out in SRTP No. 1, Tax Return Postions (1988 rev.) (the realistic possibility standard). The term also includes a position taken on a prior year's return that no longer meets the standards due to legislation, judicial decisions or administrative pronouncements having retroactive effect. (54) SRTP No. 6, 9.03; SRTP No. 7, 9.03. (55) Letter to the authors from the Director (2/7/91). (56) See SRTP No. 6, n. 1; STRP No. 7, n. 1. (57) Guide, note 39, p. 20-10. (58) Id.; see also Cogdell, note 39. (59) See Standards, note 5 1, [subsections] 402.2 to 402.3.2. (60) SRTP No. 1, [paragraph][paragraph] 9.04 and .06.