Avoiding tax malpractice.

• Author: Holub, Steven F.
• Position: TaxPractice Management

The possibility of being sued for malpractice is a major problem for tax practitioners. However, there are several basic steps practitioners may take to diminish this possibility.

Tax Malpractice

Malpractice occurs when a practitioner fails to adhere to generally accepted professional standards. Depending on the degree involved, it may include ordinary negligence, gross negligence or fraud.

Ordinary negligence. Ordinary negligence is an absence of reasonable care, as in neglecting to consider all the facts or to ask the right questions. For example, in Cohen & Stafford v. Shaines, DC NH, 4/25/01, accountants failed to inquire about prior stock transfers and their effect on a client's unified estate and gift tax credit.

In the case, Irene Levy was the majority shareholder of a closely held corporation. After her husband's death in the late 1980s, Mrs. Levy relied on her attorney for estate planning decisions, which included transferring stock in the corporation to her son. These transfers exhausted nearly all of her unified tax credit.

Over the course of many years, Mrs. Levy elected to have her salary and dividends carried as shareholder loans; by 1993, these loans totaled $900,000. Mrs. Levy and her accountants met with her attorney to discuss capitalizing these loans to the corporation as an estate planning device. At no time during the meeting did her accountants inquire about the status of Mrs. Levy's unified tax credit, and at no time did her attorney mention it.

When Mrs. Levy found she owed $135,000 in taxes and interest, she sued her accountants (but not her attorney) for malpractice, for failing to ascertain the status of the unified credit and not informing her of the tax implications.

The accountants settled with Mrs. Levy and sued the attorney for failing to inform them of the status of the unified credit, implying that the attorney must have known that Mrs. Levy had filed previous gift tax returns reporting the stock transfers. The court denied the attorney's motion to dismiss the suit.

Gross negligence. Gross negligence is the absence of even slight care. Streber, 138 F3d 216 (5th Cir. 1998), rev'g TC Memo 1995-601, is an example of gross negligence, which occurred when an attorney did tax research in preparation for litigation six years after he gave tax advice.

Terry and Tracy Parker were the beneficiaries of a trust agreement created by their father. In 1985, each received $1.7 million dollars and $225,000 in real estate...