570 Lec. 26-1
CHAPTER 26
PRACTICE ISSUES
I.
Types of IRS Audits
A. Correspondence audits
1. The return is checked for mathematical accuracy or clearly erroneous deductions,
etc., soon after the return is filed
2. Several months after filing, all 1099s and W-2s and other matching information is
verified
3. If a discrepancy is found in either of these cases, the IRS simply sends the
taxpayer an explanatory letter and a bill or a refund
B.
Office audits
1. Frequently limited in scope, and can be conducted in the IRS office or by mail
2. The taxpayer is generally asked to substantiate the items requested (i.e., present
invoices, canceled checks, etc.)
C. Field audits
1. Commonly used for corporate returns and for returns of individuals engaged in
business or professional activities
2. Generally conducted at a taxpayer’s home or business
II.
D. The following may represent the taxpayer in any type of audit
1. The taxpayer
2. The taxpayer’s CPA, attorney or enrolled agent
3. Full-time employees of the taxpayer
4. Officers, partners, trustees, executors
.
Taxpayer Penalties
A. Failure to file a tax return (§6651)
1. Penalty is 5% per month (up to 25%) on amount of tax due
2. Minimum penalty is $135
3. If failure is due to fraud, rate is 15% per month (up to 75%)
B.
Failure to pay tax due (§6651)
1. Penalty is 1/2% per month (up to 25%) on amount of tax due
2. Penalty is doubled if taxpayer fails to pay tax after receiving a deficiency
assessment
 Both penalties can be eliminated if “reasonable cause” exists for failure to file or pay
 Failure to file penalty is reduced by any failure to pay penalty for the same month
C. Accuracy-related penalties (§6652)
1. 20% of portion of tax underpayment due to:
Negligence or intentional disregard of law,
Substantial understatement of tax liability
Substantial valuation overstatement
Substantial valuation understatement
a) Penalty applies only if taxpayer fails to show a reasonable basis for the
position taken on the tax return
570 Lec. 26-2
2.
3.
Negligence
a) Any failure to make a reasonable attempt to comply with the tax law
b) Also applies to any disregard of rules and regulations whether careless,
reckless, or intentional
c) Applies to all taxes except when fraud is involved
d) Can be avoided upon showing reasonable cause
Substantial understatement of tax liability
a) Occurs when tax understatement exceeds the larger of 10% of amount due or
$5,000 ($10,000 for a C corporation)
b) Applies unless:
The taxpayer has “substantial authority” for the tax treatment
Relevant facts are disclosed in the tax return (Form 8275 is used for this)
D. Civil fraud penalty (§6653)
1. 75% penalty on any underpayment resulting from fraud by the taxpayer
2. IRS has burden of proving taxpayer civil fraud “by a preponderance of evidence”
E.
Criminal penalties (§7201)
1. Various monetary fines and/or imprisonment may be assessed
2. IRS has burden of proof to show guilt “beyond the shadow of any reasonable
doubt”
F.
Failure to pay estimated taxes (§6654 & 6655)
1. Applies to individuals, corporations, trusts, and certain estates
2. Penalty is not imposed if tax due < $500 for corporations, $1,000 for all others
G. Statutes Of Limitations
1. In general, any tax imposed must be assessed within 3 years of filing the return
(or, if later, the due date of the return)
a) Exceptions to the 3-year rule include:
If no return is filed or a fraudulent return is filed, there is no statute of
limitations
If taxpayer omits gross income > 25% of gross income stated on the return,
statute of limitations is extended to 6 years
2. Refund claims
a) Must be filed within 3 years of filing the tax return or within 2 years following
payment of the tax, if later
b) A 7-year period applies to claims relating to bad debts and worthless
securities
570 Lec. 26-3
III. Preparer Responsibilities
A. IRC Provisions
1.
2.
Who is a tax preparer?
- An individual who prepares a substantial portion of an income tax return for
compensation. (A person who employs another to do so is also a preparer.)
A preparer must:
a) sign returns
b) provide his/her id. number and than of his/her employer
c) provide a copy of the return to the taxpayer when or before presenting the return
for the taxpayer to sign
d) retain for 3 years a copy of returns prepared or a list of persons for whom returns
were prepared with certain info.
f) retain information on all employed preparers.

3.
a $50 penalty is imposed for failing to follow the procedures above
$1,000 penalty is imposed on a preparer if any part of an understatement of tax liability
resulted from an unrealistic position, the preparer knew or should have known of the
unrealistic position, or the position was either frivolous or not disclosed.
a) Disclosure will not avoid the penalty unless there is a reasonable basis for the
position.
Reasonable is defined as ~ 1 in 3 chance of success.
b) Understatement penalties may be excused if there is reasonable cause and good
faith.
 Frivolous positions result in a $500 penalty.
4.
$5,000 (or 50% of fee charge, if larger) penalty is imposed on a preparer if any part of
an understatement of tax liability resulted from a willful attempt to understate it, or from
reckless or intentional disregard of rules or regulations.
a)
The $5,000 is reduced by the $1,000 penalty if both are imposed
5.
Preparer must make appropriate inquiries to determine the existence of facts required
by the IRC or regulation as a condition to claiming a deduction.
6.
Preparer may generally rely in good faith without verification on information furnished
by the taxpayer, although the preparer may not ignore the implications of information
furnished to the preparer or actually known to the preparer.
a) Preparer may use estimates provided by the taxpayer if they are reasonable under
the circumstances.
7.
Preparers are subject to penalties for using or disclosing information other than for
return preparation ($250, up to a maximum of $1,000 per disclosure)
570 Lec. 26-4
B. Circular 230 (issued by the Treasury Department) Provisions
1. Places certain restrictions on who can practice before the IRS. With certain notable
exceptions, such practice is limited to attorneys, CPAs, and EAs.
2.
Contains following requirements:
a) Disclose nonfrivolous tax return positions that fail the realistic possibility standard
(Form 8275)
b) Inform clients of penalties likely to apply and ways to avoid
c) Inform clients any error or omission the client may have made
d) Submit records lawfully requested by the IRS
e) Exercise due diligence in preparing and filing tax returns accurately (i.e., remain
current in tax laws)
f) Not unreasonably delay disposition of matters before the IRS
g) Not charge an “unconscionable fee” for tax services & representing clients before
the IRS
h) Not represent clients with conflicting interests
i) To be followed in written advice to clients (new)
j) To be followed for “covered opinions” (new)
k) Contains “Best Practices” for tax advisors (new)
C. AICPA Statements on Standards for Tax Services (SSTSs)
1. General.
a) SSTSs are enforceable tax practice standards.
2.
Specific Statements
#1. Tax return positions
a) CPA should not recommend a position unless he has a good faith belief that the
position has a “realistic possibility” of being sustained if challenged. (May reach
such a conclusion on the basis of well-written articles, treatises, IRS General
Counsel Memoranda, and private letter rulings.)
b) CPA should not prepare or sign a return as an income tax preparer if he knows it
takes a position that cannot be recommended as stated in (a) above.
c) Despite (a) & (b), CPA may recommend a position that is not frivolous (knowingly
in bad faith and improper) as long as the position is disclosed on the return.
d) CPA should advise client of possible penalty consequences associated with the
recommended tax position.
e) CPA should not recommend a position that exploits the IRS audit selection
process, or is advanced solely to obtain leverage in the bargaining process with
the IRS.
f) CPA has the right and responsibility to be an advocate for the client. A taxpayer
has no obligation to pay more taxes that legally owed.
#2. Answers to questions on returns
a) CPA should make a reasonable effort to obtain appropriate answers to all
questions on a tax return before signing as preparer.
b) Reasonable grounds for omitting an answer:
 Information is not readily available, and the answer is insignificant with respect to
taxable income or the tax liability.
 Genuine uncertainty exists as to the meaning of the question.
570 Lec. 26-5

The answer to the question is voluminous, and the return states that the date will
be supplied upon examination.
c) CPA is not required to explain on the return the omission of an answer when
reasonable grounds exist for the omission.
#3. Procedural aspects of preparing returns
a) CPA may rely without verification on information provided by the client.
However, reasonable inquiries should be made if information appears to be
incorrect, incomplete, or inconsistent on its face or on the basis of other facts
known by the CPA. In this instance, the client’s returns for prior years should be
consulted.
b) CPA should make inquiries to determine to his satisfaction whether the taxpayer
has maintained its books or has documentation to support the deductions taken.
c) CPA who signs the return should consider information known from another
client’s return if it is relevant, its consideration is necessary, and its use is not in
violation of any law.
#4. Use of estimates
a) CPA may use client’s estimates if:
 It is impracticable to obtain exact data, and
 The estimated amounts are reasonable under the facts.
b) When using the client’s estimates, they should be presented in a way that does
not imply greater accuracy than exists.
c) The client is responsible for the estimated data.
d) Appraisals and valuations are not considered estimates.
#5. Departure from positions previously concluded in administrative
proceedings or court decisions
a) The recommendation of a position should be based upon the facts and laws at
the time the return is prepared and signed. The treatment of an item as
determined in an administrative proceeding or a court decision does not restrict
the recommendation of a different tax treatment in later years, unless the client is
bound to a specified treatment in the later year.
#6. Knowledge of errors: return preparation & administrative proceedings
a) CPA should inform the client upon becoming award of an error in a previously
filed return (whether or not the CPA prepared the return), an error in a return that
is the subject of an administrative proceeding, or upon becoming aware that the
client did not file a required form.
b) CPA should recommend measures to take.
c) CPA is not obligated to inform the IRS and may not do so without the client’s
permission.
d) If the CPA is requested to prepare a return when the client has not corrected a
previous year’s error, the CPA should consider whether to continue a
professional relationship with the client or withdraw. If the CPA prepares the
current return, the CPA should take reasonable steps to ensure that the error is
not repeated.
e) If the CPA is representing a client in an administrative proceeding with respect to
a return that contains an error of which the COA is aware, the CPA should
request the client’s agreement to disclose the error to the IRS.
570 Lec. 26-6
#7. Form and content of advice to clients.
a) When providing tax advice to a client, CPA should use judgment to ensure that
the advice reflects professional competence and meets the client’s needs.
b) When advising or consulting on tax matters, CPA should follow the standards for
tax return positions (item (2), earlier).
c) CPA is not obligated to communicate with the client when subsequent
developments affect previous advice. However, CPA is obligated to do so when
helping to implement the plans associated with the advice or when the obligation
is undertaken by specific agreement.
d) Tax advice can be in any form. However, important, unusual, or complicated
transactions should be in writing.