Chapter 1 of 510–20% of exam

Area I: Ethics, Professional Responsibilities and Federal Tax Procedures

Area I covers the rules for practice before the IRS, the penalties that fall on preparers and taxpayers, how a tax dispute moves from examination to court, and the CPA's legal exposure and privileges. Most items test recall and application of specific rules to a short fact pattern.

Circular 230 and preparer rules

Treasury Circular 230 (31 CFR Part 10) governs practitioners who represent taxpayers before the IRS, and separate Code sections penalize anyone who prepares returns for pay. The classic confusions are what a practitioner must do on discovering a client's error, when contingent fees are allowed, and what happens to client records in a fee dispute. Knowing who counts as a tax return preparer matters because the preparer penalties turn on it.

Client's omission

A practitioner who learns that a client has not complied with the tax law, or made an error or omission on a return, must promptly advise the client of it and of its consequences; there is no duty to report the client to the IRS.

31 CFR 10.21

Contingent fees

Generally barred, but allowed for services in an IRS examination of an original return, an amended return or refund claim filed within 120 days of written notice of an exam, claims solely for interest or penalties, and judicial proceedings.

31 CFR 10.27(b)

Client records

Records the client needs to meet federal tax obligations must be returned promptly on request, even in a fee dispute; copies may be kept. Where state law allows retention in a fee dispute, only records that must be attached to the return must be returned.

31 CFR 10.28(a)

Relying on client information

A practitioner may rely in good faith on client information but may not ignore implications and must make reasonable inquiries when information looks incorrect, inconsistent or incomplete.

31 CFR 10.34(d)

Who is a preparer

Anyone who prepares for compensation all or a substantial portion of a return or refund claim; typists, employees preparing their employer's return, and fiduciaries are excluded.

IRC 7701(a)(36)

Licensing and discipline

Three separate bodies can act against a CPA, and each controls something different. The state board of accountancy issues and can revoke the license to practice public accounting. The IRS, through Circular 230, controls the right to practice before it. Professional associations discipline their own members but cannot remove a license.

State board authority

After notice and hearing, the board may revoke, suspend or refuse to renew a license, reprimand or censure, limit practice, fine, or impose probation, for grounds such as fraud, gross negligence, felony conviction, or discipline elsewhere.

Uniform Accountancy Act (9th ed.) section 10

Circular 230 sanctions

The IRS may censure (a public reprimand), suspend or disbar a practitioner, and may impose a monetary penalty capped at the gross income derived from the conduct.

31 CFR 10.50

Preparer penalty, unreasonable position

The greater of $1,000 or 50 percent of the income from the return when an understatement stems from a position without substantial authority (or, if disclosed, without a reasonable basis) that the preparer knew or should have known of.

IRC 6694(a)

Preparer penalty, willful or reckless

The greater of $5,000 or 75 percent of the income from the return.

IRC 6694(b)

Disclosure of return information

Knowingly or recklessly disclosing or misusing return information is a misdemeanor, and a civil penalty applies as well.

IRC 7216(a); IRC 6713

Federal tax procedures

An examination can end in agreement, an appeal to the IRS Independent Office of Appeals, or a statutory notice of deficiency. The notice starts the 90-day window to petition the Tax Court without paying the tax; district court and the Court of Federal Claims hear refund suits after payment. Assessment and refund deadlines, disclosure of return positions and substantiation rules shape what a preparer can defend.

Tax Court petition

The taxpayer has 90 days after a notice of deficiency is mailed (150 if addressed outside the U.S.) to petition the Tax Court; assessment is barred meanwhile.

IRC 6213(a)

Small tax case

If the amount in dispute for a year does not exceed $50,000, the taxpayer may elect small case procedures; decisions cannot be appealed and are not precedent.

IRC 7463

Assessment period

Generally 3 years after filing (an early return is treated as filed on the due date); 6 years if gross income omitted exceeds 25 percent of the gross income stated; unlimited for fraud or no return.

IRC 6501(a), (b)(1), (c), (e)

Refund claims

Due within 3 years of filing or 2 years of payment, whichever is later.

IRC 6511(a)

Authority and disclosure

Regulations interpret the Code; revenue rulings are published IRS positions; a private letter ruling binds the IRS only for the requester and is not precedent. Positions contrary to a regulation are disclosed on Form 8275-R, other positions on Form 8275.

IRS, Understanding IRS Guidance; Instructions for Form 8275

Taxpayer penalties, privilege and records

Taxpayer penalties are mostly percentages of an underpayment, so the tested skill is identifying which penalty applies and applying it. The CPA's own legal position turns on the narrow federal practitioner privilege, which covers civil matters only, and on the absence of any general accountant-client privilege. Substantiation and foreign-account reporting are frequent fact patterns.

Accuracy-related penalty

20 percent of the underpayment attributable to negligence or a substantial understatement; for individuals, an understatement is substantial if it exceeds the greater of 10 percent of the correct tax or $5,000 (5 percent if a QBI deduction is claimed).

IRC 6662(a), (d)(1)

Failure to file and pay

5 percent per month (maximum 25 percent) for late filing and 0.5 percent per month for late payment; the filing addition is reduced by the payment addition for months both apply. Civil fraud carries 75 percent.

IRC 6651(a), (c)(1); IRC 6663

Practitioner privilege

Tax advice from a federally authorized practitioner gets attorney-client confidentiality, but only in noncriminal matters before the IRS and in federal court, and not for written tax-shelter promotion.

IRC 7525

No general accountant privilege

Federal law recognizes no confidential accountant-client privilege, and auditors' tax accrual workpapers have no work-product immunity from an IRS summons.

Couch v. United States, 409 U.S. 322 (1973); United States v. Arthur Young & Co., 465 U.S. 805 (1984)

FBAR

A U.S. person with foreign financial accounts whose aggregate value exceeded $10,000 at any time in the year files FinCEN Form 114 electronically, due April 15 with an automatic extension to October 15.

IRS FBAR guidance (Bank Secrecy Act)

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