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Why Your Accountant Is Probably An Unpaid Auditor For The IRS

By Tim Berry, JD - Email Editor

Date : July 23, 2009

Dear Valued Reader,

I would hate to be an accountant right now.

Unfortunately, due to recent pressures put upon accountants, I think they are going to be forced to make some changes.

Over the last couple of years it seems the IRS has been coming out with proposals that would effectively make tax preparers unpaid employees of the IRS. This came to a head in May of 2007 when Congress changed a key code section for tax positions taken by tax preparers. Before the change, the tax preparer just had to feel there was a realistic possibility of success that the service would agree with the position, (a very low standard). After the change, the standards became “more likely than not”.

Let’s pause for a moment and reflect upon the complexity of the tax code. It is composed of thousands of pages with court cases, PLRs, admin rulings, etc. . . adding tens of thousands of more pages of interpretation. How could a preparer be sure it was more likely than not the positions taken on a return would withstand scrutiny? Then there was the concern of confirming every statement a client made. For example, if a client said they had a home based business, the tax preparer would need solid proof of the validity of the business before business deductions could be taken for the business. In effect, the IRS had an unpaid auditor.

Other than being a good citizen, why would the tax preparer go to these lengths? Under the new changes in the code section, if the service felt like the position taken on the tax return did not meet the more likely than not standard, the service could penalize both the tax payer and the tax preparer. In the case of the tax preparer the fines could be $1,000 or 50% of the amount the preparer charged for the return, and they could be subject to disciplinary action.

Step into your tax preparer’s shoes. What would you do? If you charged a client $750 to do a return, but could be subject to the above fines, how would you react? Would you offer your client any advice? Would you be willing to take their word on questionable issues? Or would you be afraid—yes, afraid—to do anything at all out of the ordinary?

Fortunately the IRS came out with a Notice which eased up a bit on the requirements imposed by the new code section. The notice in general said the tax preparer would be considered to have met their standard in regard to a client’s tax position, if the preparer counseled the client about potential penalties and, “contemporaneously documents in the tax return preparer’s files that this advice was provided.”

Do you see what just happened? What the IRS giveth, the IRS taketh. Sure, they lowered the standards so as to make tax preparers breathe a little easier, but only if the tax preparer documents they warned the client about the potential penalties. What do you think is going to be the first thing a revenue agent is going to ask for upon the initiation of an audit? Probably the client file.

Wait, isn’t there an accountant-client privilege? Loosely speaking , yes there is, but it is more of an exception than a rule. As a general rule the accountant-client privilege does not cover communications about tax return preparation. What do you think the IRS is going to consider the little talk your preparer had with you about penalties? Now the IRS has a complete roadmap, created by your preparer, on exactly the issues on which you took an aggressive position.

Pretty scary isn’t it?

Another pressure accountants have to put up with is all the standards that are required of them. In particular there is a body known as the Financial Accounting Standards Board (FASB). The FASB is “the designated organization in the private sector for establishing standards of financial accounting. “

To put it very simply, if your accountant doesn’t follow FASB rules they are in deep doo doo.

Back in 2006, The FASB issued Interpretation 48, Accounting for Uncertainty in Income Taxes. At the time this was an accounting rule for publicly traded companies. Under Interp. 48 the accountant is to analyze the tax positions taken by the client. If the positions did not meet a “more likely than not” standard, the accountant is to make a notation of such on the companies financials, along with an estimate of the value of the tax benefit.

One accounting firm’s best practices for handling the issue included that “each tax position identified should be catalogued (typically on an Excel spreadsheet) highly certain, uncertain, or borderline immaterial”.

Remember the title to this article? This pretty much sounds like an audit of the tax positions the client has taken, doesn’t it? Who gets to pay for this investigative work? Is the IRS going to be able to demand these work papers as part of an audit? There is a key court case going through the system on this very question.

Here’s the real punch line. Back in 2006 these accounting standards only applied to public companies. On July 8th, The FASB held a board meeting wherein it was decided Fin. 48 compliance would apply to most nonpublic companies 2009 year end, and future, financial statements.

What this means to you is that in the future, when you have a CPA prepare financials for your company, they will be required to analyze (dare I say audit) your tax positions to see if they meet the “more likely than not” probability of success. They will also be generating paperwork documenting their positions with those positions being noted in your financials. Fin 48 along with the new tax preparer rules go a long way towards creating an adversarial relationship between you and your advisors.

You might think you can get around all this by just not having an accountant prepare your financials, and thus, not have to comply with Fin 48. That may work out if you’re a mom-and-pop operation, but the real kick in the pants is that compliance with the FASB rules, and thus Fin 48, is a part of what is known as Generally Accepted Accounting Principles, or GAAP. For many of you, if you have had credit extended to your company, the loan/lease covenants probably require your company to comply with GAAP. If you don’t comply with GAAP, the financial institution now has the excuse it was looking for to pull your loan.

No one ever said it was a fair world out there.

Until next time,

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