Tax practice standards for the new millennium.

• Author: Gardner, John C.

Tax practice has never been more challenging than it is today. Tax advisers face increasing competition, complexity and threat of suit, creating a need for familiarity with the various sets of legal and professional standards applicable to tax practice. This article examines several such standards and the AICPA's recent decision to make its Statements on Responsibilities in Tax Practice enforceable.

Modern tax practice is characterized by multifaceted challenges at the local, state, Federal and international levels, as CPAs engage in complex tax planning and compliance for businesses and individuals. CPA tax practitioners must regularly confront globalization, value billing, increased liability premiums and claims, technical complexity, dysfunctional tax authorities and an increasingly competitive marketplace. Tax practitioners also face numerous regulations and professional tax practice standards, as well as the possibility of tax penalties. These realities require practitioners and their firms to be thoroughly acquainted with the legal, technical and professional standards that may affect their practices, service to clients and ability to operate profitably in the new millennium.

Tax issues represent a large proportion of liability premiums and claims for CPAs. According to recent insurance data, "[c]laims arising from the tax practice of CPAs insured under the AICPA Professional Liability Insurance Program constitute over 55% of total claims made ... Within the tax area, engagements for individuals account for 59% of total tax claims, while those for C-Corps and S-Corps account for 25% and 12%, respectively."(1) In addition to both a more competitive market and the threat of lawsuits, increased regulation within the profession and from external taxing authorities also affects practitioners' ability to operate successfully.

This article reviews the standards that affect CPAs in tax practice, including Sec. 6694 and other penalty provisions, Circular 230,(2) the AICPA Code of Professional Conduct (CPC) and related Rules of Professional Conduct (RPCs), and the AICPA Tax Division's Statements on Responsibilities in Tax Practice (SRTPs).(3) It examines judicial and legislative efforts to enforce the SRTPs, along with a recent decision by the AICPA Council to permit the Tax Executive Committee to become a standard-setting body and initiate the process to make the SRTPs enforceable (see also Tax Practice Management, "SRTPs to Become Enforceable" p. 188, this issue). Finally, it considers the implications for AICPA members and other CPAs of making the SRTPs enforceable.

Sec. 6694 Preparer Penalties

Tax practitioners must comply with several sets of tax practice standards as they interact with government agencies, clients and others. Sec. 6694 codifies the "realistic possibility" standard for signing and nonsigning return preparers. Using language from the SRTPs and American Bar Association (ABA) Opinion 85-352,(4) Sec. 6694 and Regs. Sec. 1.6694-2(a) impose a $250 penalty on a preparer for understating tax liability on a return or refund claim if he "knew or reasonably should have known" that the tax position lacked a realistic possibility of being sustained on its merits. Regs. Sec. 1.6694-2(b)(1) provides that a position is considered to have a realistic possibility of being sustained on its merits if a reasonable and well-informed analysis by one knowledgeable in tax law would lead him to conclude that it has approximately a one in three (or greater) likelihood of being sustained on its merits. In making this determination, the possibility that the position will not be challenged by the Service (e.g., because the taxpayer's return may not be audited or because the issue may not be raised on audit) is not to be taken into account.

Substantial Authority

The authorities used to determine whether a tax practitioner has met the realistic possibility standard are the same as those used by Regs. Sec. 1.6662-4(d)(3) (iii) in determining whether a taxpayer has substantial authority to take an undisclosed return position and avoid the Sec. 6662(b)(2) substantial understatement penalty. These authorities generally include court cases, regulations, revenue rulings, notices and other sources issued by Treasury; the regulation does not permit use of secondary sources (e.g., treatises or articles) as authority, although the taxpayer may use the underlying primary sources cited in articles or treatises. Regs. Sec. 1.6662-4(d)(3)(ii) outlines the type of analysis used to determine whether substantial authority exists for taxpayers; Regs. Sec. 1.6694-2(b)(1) directs that this process also be used by preparers in determining whether the realistic possibility standard has been met.

Practitioners who determine that the Sec. 6694(a) realistic possibility standard is satisfied may recommend a return position and/or sign a return without specifically disclosing the position. A return position that does not meet the realistic possibility standard, but which is not frivolous (defined by Regs. Sec. 1.6694-2(c)(2) as "patently improper"), may not result in a preparer penalty if adequately disclosed. Generally, under Regs. Sec. 1.6694-2(c)(3)(i), disclosure on the return in accordance with an annual revenue procedure or on a properly completed and filed Form 8275, Disclosure Statement, or 8375-R, Regulation Disclosure Statement, as appropriate, is adequate. The rules for both signing and nonsigning preparers should be scrutinized for adherence to detail for both disclosed and nondisclosed return positions.

Reasonable Cause Exception

Regs. Sec. 1.6694-2(d) provides that the Sec. 6694(a) penalty does not apply if the understatement was due to reasonable cause and the preparer acted in good faith. Reasonable cause is discussed in Regs. Sec. 1.6694-2(d)(1)-(5) and involves an examination of the preparer's normal office practice; the nature, frequency and materiality of the errors; the complexity of the issues involved; and whether the issue was uncommon or highly technical. A preparer may also be able to avoid penalties if he relied in good faith on the advice of another preparer, if the preparer had reason to believe that the person rendering the advice was competent. Thus, under Regs. Sec. 1.6694-2(d)(5)(ii), if a preparer who relied on the advice knew or should have known that the person rendering it was not aware of all relevant facts, the reasonable cause exception is not available. Nor is the exception available, under Regs. Sec. 1.6694-2(d)(5)(iii), if the preparer knew or should have known (given the nature of his practice) that, when the advice was given, it was no longer reliable, due to changes in the law. The preparer relying on the advice must also prove that it was...