Tax practitioners have a duty to promptly disclose to a client errors they discover in the client's previously filed tax returns. This duty is set forth in the AICPA Statement on Standards for Tax Services (SSTS) No. 6, Knowledge of Error: Return Preparation and Administrative Proceedings, and Section 10.21 of Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10). As discussed in the first part of this two-part article in the June issue, these standards differ from each other in scope and extent of duties, but both agree that the tax practitioner must promptly communicate the error to the client and advise the client of its consequences. They also both serve three overarching goals of tax policy: preserving the self-assessment system, protecting the interests of the client, and establishing the practitioner as the keeper of a duty to the tax regime itself.
These two rules together (which this article refers to collectively as "the Rule") may seem simple and straight-forward, but they require reflection and analysis in many situations. In this second part, the article discusses what tax practitioners must do if their client fails to heed their advice and what to do when the error is attributable to the tax practitioner's own advice.
What If the Client Fails to Heed the Advice?
Assuming that the tax practitioner has discovered an error in a previously filed return (1) and that, as generally contemplated by the Rule, the tax practitioner has informed the client of the error, advised the client of its consequences, and recommended corrective measures, what is the tax practitioner to do if the client declines to follow the recommendations? As a threshold matter, at least two things are clear. First, according to SSTS No. 6, the ultimate decision regarding corrective action is solely the client's: "It is the taxpayer's responsibility to decide whether to correct the error." (2) Second, unless required to do so by law, the tax practitioner is prohibited from unilaterally disclosing the matter to the IRS: "The member is not allowed to inform the taxing authority without the taxpayer's permission, except when required by law." (3)
Beyond these essential principles, however, the tax practitioner is left without comprehensive guidance regarding what to do when the client does not sprint to the IRS with an amended return in hand. For example, does the tax practitioner have an ethical obligation to push the reluctant client to take corrective action? Alternatively, what if the client wishes to pursue "rough justice" by taking approximate corrective action on a current return rather than by following the technically correct course and amending one or more prior returns? These and related issues are considered below.
How Readily Can the Tax Practitioner Take "No" for an Answer?
By their very terms, SSTS No. 6 and Circular 230 place the tax practitioner firmly in the position of information conduit to the client. SSTS No. 6 requires only that the error, its consequences, and the recommended corrective action be conveyed to the client. For its part, Circular 230, Section 10.21, does not even oblige the tax practitioner to furnish recommendations. Thus, the Rule conceptualizes tax practitioners solely as purveyors of information, not as decision-makers or even as the conscience of the client.
Accordingly, from the perspective of the tax practitioner, "no" from a client in this context really does mean "no." Once tax practitioners have complied with the terms of the Rule and have properly documented that compliance, they have thereby fulfilled their ethical obligations and can feel comfortable accepting a client's decision not to take corrective action, so long as the decision does not affect the practitioner's continued representation of the client concerning current and future returns. Indeed, tax practitioners would be overstepping their bounds if they refused to take "no" for an answer or, arguably, even if they posed serious resistance to a client's decision not to amend.
For a decision of such magnitude, however, it is reasonable for tax practitioners to assure themselves that the client is adequately informed of the issues and that, if the client is a company, the decision is coming from someone with a reasonably high level of responsibility within the company. Of course, such elevation of the decision to forgo corrective action must be done with some sensitivity to avoid damage to day-to-day working relationships within the company. But, if managed adroitly, this elevation of the discussion can provide tax practitioners with reasonable assurance that the decision is well-informed and can help them feel justified that they are properly fulfilling their duties to the client as well as to the larger self-assessment system.
How Does a Refusal to Take Corrective Action Affect the Client Relationship?
A guiding principle of the Rule is that the authority to determine whether to undertake corrective action rests solely with the client. Circular 230, Section 10.21, provides no direction to the tax practitioner regarding subsequent interactions with the noncorrecting client. While SSTS No. 6 reinforces the primacy of the client's authority, it also encourages tax practitioners to think long and hard about whether it would be advisable to withdraw from further representation of the client. (4)
This admonition on the part of SSTS No. 6 to consider withdrawal, although perhaps coercive or even punitive in its application, is primarily intended to provide the tax practitioner with preemptive protection from two equally undesirable situations. First, if a client refuses to correct an error in a prior year and the erroneous item would continue to the current-year return, continuing to represent the client will lead to a situation where the tax practitioner's professional obligations and the client's interests will almost surely be on a collision course.
Such is the case because, while the Rule requires tax practitioners to recommend correcting a prior error, the practitioner is affirmatively precluded from signing a current return known to include such an error. For example, Circular 230, Section 10.34, prohibits a practitioner from willfully, recklessly, or through gross incompetence signing a tax return or claim for refund that the practitioner knows or reasonably should know contains a position that lacks a reasonable basis. (5)
Moreover, Sec. 6694 imposes a range of tax preparer penalties for conduct giving rise to certain understatements of liability on a return. Thus, if the tax practitioner is to continue representing a nonamending client, the error will need to be corrected on a forward-looking basis.
Nevertheless, such a midstream change in the treatment of an item will likely be an "audit flag" highlighting the erroneous treatment in the earlier year. Therefore, a client, having decided not to amend, may well place pressure on the tax practitioner to continue rolling the error forward, pressure to which the tax practitioner simply cannot succumb.
Example 1: Taxpayer T has had ongoing nexus in State A but failed to file State A returns in prior years. The tax practitioner, who is an AICPA member, becomes aware of the omission and advises T to correct the error, which T refuses to do. SSTS No. 6 explicitly requires the practitioner to insist that a State A return be prepared and filed in the current year.' To further complicate matters, assume that the practitioner believes that filing the current-year return may well lead State A to scrutinize the lack of returns in prior years.
Such a conundrum will test the mettle of even the most ethical of practitioners and is virtually guaranteed to imperil even the most collegial of practitioner/client relationships. As a result, SSTS No. 6 urges tax practitioners to consider these tensions and then, if they decide to continue with the client, to remain steadfast and demand that the item be properly reported in the current year. Any negative potential consequences for the client from that proper reporting should then be fully explained to rhe client. SSTS No. 6 states:
If a member is requested to prepare the current year's return and the taxpayer has not taken appropriate action to...