Preparer error

[kamckinley]

I just discovered an error that I made on a client's 2012 tax return. They had rental losses which should have been carried forward due to their income being too high ($185K). Unfortunately, I had checked the non-passive box on the Sch E entry form, so the losses showed up on the tax return when they shouldn't have. I know the rule regarding rentals and losses, I just didn't catch the error on this return. This is a last minute filer and frankly, I was just dead tired when I prepared this return; not making excuses, it was totally my fault...

Anyway, the client now owes several thousand dollars in taxes and penalties. I know I need to own up to my mistake, but just wondering the best way to handle preparer mistakes, especially when there are large penalties involved. Since the mistake was mine, I know I need to refund the penalties the client owes to the client. From previous tax firms I worked for, they did not refund interest charges because the client had the use of the money during that time. Is that standard practice or do you usually refund both penalties and interest charges? If the penalties are really large, do you file a claim with your E&O insurance or just find a way to pony up the money? I have made mistakes before - we're human, we all do - but never one this large. Any advice on the best way to handle this is greatly appreciated.

Not a good way to start the tax season

Kristine

[ATSMAN]

I just discovered an error that I made on a client's 2012 tax return. They had rental losses which should have been carried forward due to their income being too high ($185K). Unfortunately, I had checked the non-passive box on the Sch E entry form, so the losses showed up on the tax return when they shouldn't have. I know the rule regarding rentals and losses, I just didn't catch the error on this return. This is a last minute filer and frankly, I was just dead tired when I prepared this return; not making excuses, it was totally my fault...

Anyway, the client now owes several thousand dollars in taxes and penalties. I know I need to own up to my mistake, but just wondering the best way to handle preparer mistakes, especially when there are large penalties involved. Since the mistake was mine, I know I need to refund the penalties the client owes to the client. From previous tax firms I worked for, they did not refund interest charges because the client had the use of the money during that time. Is that standard practice or do you usually refund both penalties and interest charges? If the penalties are really large, do you file a claim with your E&O insurance or just find a way to pony up the money? I have made mistakes before - we're human, we all do - but never one this large. Any advice on the best way to handle this is greatly appreciated.

Not a good way to start the tax season

Kristine

Kristine, we all make mistakes especially when we are rushed, so don't beat yourself over it. Is your client reasonable?

You may want to work with your E&O carrier or attorney before you settle this with the taxpayer because you want to make sure it is resolved for good.

In one situation where it was my mistake, I gave the client the penalty after negotiating it down with the IRS and 50% of the interest (same reasoning you used). Also I did their tax returns for free for the next 2 years. My client was upset but understood that mistakes happen, we are all humans and as long as you make it up to them most people will not threaten to sue you! My mistake cost me roughly $1000 bucks. My attorney friend drafted a settlement agreement and we worked it out.

[New York Enrolled Agent]

I just discovered an error that I made on a client's 2012 tax return. They had rental losses which should have been carried forward due to their income being too high ($185K). Unfortunately, I had checked the non-passive box on the Sch E entry form, so the losses showed up on the tax return when they shouldn't have. I know the rule regarding rentals and losses, I just didn't catch the error on this return. This is a last minute filer and frankly, I was just dead tired when I prepared this return; not making excuses, it was totally my fault...

Anyway, the client now owes several thousand dollars in taxes and penalties. I know I need to own up to my mistake, but just wondering the best way to handle preparer mistakes, especially when there are large penalties involved. Since the mistake was mine, I know I need to refund the penalties the client owes to the client. From previous tax firms I worked for, they did not refund interest charges because the client had the use of the money during that time. Is that standard practice or do you usually refund both penalties and interest charges? If the penalties are really large, do you file a claim with your E&O insurance or just find a way to pony up the money? I have made mistakes before - we're human, we all do - but never one this large. Any advice on the best way to handle this is greatly appreciated.

Not a good way to start the tax season

Kristine

Why don't you first try to have the penalties abated?

A request for abatement should be written under the taxpayer's name. The taxpayer can assert preparer error which is the truth. It is important that the taxpayer seeks relief - not you as the preparer.

The Tax Court has often stated the requirements for reliance on a tax professional as a defense for penalty abatement.

1. The tax pro was competent
2. The taxpayer provided the necessary & correct information
3. The taxpayer actually relied in good faith on the pro's judgment

You can also cite Reg. §1.6664-4(c). There is also information in the IRM in part 20. Not easy to do but consider giving it a try.

BTW, pay the interest as a good will gesture - it's peanuts compared to the penalty.

[kamckinley]

Why don't you first try to have the penalties abated?

A request for abatement should be written under the taxpayer's name. The taxpayer can assert preparer error which is the truth. It is important that the taxpayer seeks relief - not you as the preparer.

The Tax Court has often stated the requirements for reliance on a tax professional as a defense for penalty abatement.

1. The tax pro was competent
2. The taxpayer provided the necessary & correct information
3. The taxpayer actually relied in good faith on the pro's judgment

You can also cite Reg. §1.6664-4(c). There is also information in the IRM in part 20. Not easy to do but consider giving it a try.

BTW, pay the interest as a good will gesture - it's peanuts compared to the penalty.

The client didn't tell me about the notice until they had passed the final deadline to respond. They got their first notice back in November 2014, got two more notices, and the final notice had a deadline of last Friday. I'm guessing that since they failed to respond to any of the notices (including the one last week), that they will have a hard time getting any penalties abated. I had no idea this was going on until she called me on Friday. Would you still try knowing this?

But that brings up another point... had she called me when she received the first notice, I might have been able to get some of the penalties abated. That's probably not possible now. Even though the original error was mine, I feel like I shouldn't be responsible for all of the penalties and interest given the fact that she waited so long to tell me about it. Does that change anything said so far?

Thanks again. I'm just sick over this...

[ATSMAN]

NYEA bring up a very good point. I got penalties reduced but my client sent me the notice the same day they got it! You should try and chances are if you take full responsibility IRS may abate or reduce the penalty.

My engagement letter does specify that they must contact me immediately for any notice they received for a return I prepared before responding to IRS or state DOR.

Do you have an engagement letter with this client?

[New York Enrolled Agent]

The client didn't tell me about the notice until they had passed the final deadline to respond. They got their first notice back in November 2014, got two more notices, and the final notice had a deadline of last Friday. I'm guessing that since they failed to respond to any of the notices (including the one last week), that they will have a hard time getting any penalties abated. I had no idea this was going on until she called me on Friday. Would you still try knowing this?

But that brings up another point... had she called me when she received the first notice, I might have been able to get some of the penalties abated. That's probably not possible now. Even though the original error was mine, I feel like I shouldn't be responsible for all of the penalties and interest given the fact that she waited so long to tell me about it. Does that change anything said so far?

Thanks again. I'm just sick over this...

You say they got a final notice - was it a 90-day letter with a last day to file a petition of 1/30/15 ?

[kamckinley]

You say they got a final notice - was it a 90-day letter with a last day to file a petition of 1/30/15 ?

I believe so. I still haven't seen any of the notices, but based on what the client told me I believe that is correct. Thanks again!

[kamckinley]

NYEA bring up a very good point. I got penalties reduced but my client sent me the notice the same day they got it! You should try and chances are if you take full responsibility IRS may abate or reduce the penalty.

My engagement letter does specify that they must contact me immediately for any notice they received for a return I prepared before responding to IRS or state DOR.

Do you have an engagement letter with this client?

I do have an engagement letter, but the wording regarding IRS notices is pretty vague: "If your returns are later selected for review or audit by taxing authorities, we will be glad to assist or represent you if you desire. Our fees for preparing your returns do not include time that might be necessary to assest you during a taxing authority review." - not sure that's going to help much with this client, I will revise it for future engagements.

[New York Enrolled Agent]

I believe so. I still haven't seen any of the notices, but based on what the client told me I believe that is correct. Thanks again!

We all make mistakes so move on from that.

You need to see all the notices. But, I'm reasonably sure the TP was hit with an accuracy related penalty under §6662. That penalty = 20% and whether your client sent you the notice in November or just now, that 20% is not going to change. Forget worrying about the timing and if the penalty/interest is a couple of dollars more. That really isn't the issue - the error was yours and IMO I believe the penalty/interest is yours.

It is always harder to get a penalty abated after payment rather than before imposition of the penalty. That's where the client hurt you. If the time for the 90 day letter is gone, the taxpayer can pay the tax and the penalty and then you can prepare a Form 843 requesting abatement and a refund of the penalty using the reliance on the tax pro defense. More likely than not, the request will be denied but then you will get the right to seek an Appeals Officer to hear your case.

[Burke]

Since the mistake was mine, I know I need to refund the penalties the client owes to the client. From previous tax firms I worked for, they did not refund interest charges because the client had the use of the money during that time. Is that standard practice or do you usually refund both penalties and interest charges? If the penalties are really large, do you file a claim with your E&O insurance or just find a way to pony up the money? . Kristine

Legally, you are not required to do this. It is not an IRS regulation. The taxpayer is responsible. However, all tax preparers have some sort of policy as to what they will do and not do, even if it is not written down. It varies. As you say, the former firm refunded penalties but not interest. Your relationship with the client makes a difference in your decision, but once you have a policy, it should be consistent. Check your E&O and see if it says anything.

[BHoffman]

Hi Kristine - Sorry to hear this.

Just some advice: You might want to look at any other clients where this same situation occurred in open years. Penalties are hardly ever imposed on amended returns.

Good luck!

[AZ-Tax]

Have TP sign form 2848 when TP signs tax return

Have TP sign form 2848 when TP signs tax return. I started this practice with approx. 1/2 my clients and this year I aim to have all of my clients sign them. This way I will be permanent POA and receive copies of all IRS correspondences unless TP changes POA.

[Corduroy Frog]

Subsequent Recoveries

All of the foregoing advice is good and from worthy sources. But I will add just one more factor which
may ease the pain.

You say the error occurred on the 2012 return after you reported rental losses with AGI too high. I guess my
first question is how this happened if you had good software. The software should have populated the f8582
with appropriate numbers and disallowed the loss. It would thus be impossible to deduct the loss unless you
had poor software, or else overrode good software controls.

Secondly, it is possible that these suspended losses could have been released in 2013, or maybe even 2014.
That would result in a considerable refund if 2013 can be amended. This would not cancel the penalties on
2012, but it might help if the taxpayer can have these suspended losses launched. Of course, this won't
happen if they continue to make significant income but it's worth looking into. If you took the loss in 2012,
the 2013 return would not have any knowledge of suspended losses.

Good luck. We all try to help each other on this forum.

[David1980]

You say the error occurred on the 2012 return after you reported rental losses with AGI too high. I guess my
first question is how this happened if you had good software. The software should have populated the f8582
with appropriate numbers and disallowed the loss. It would thus be impossible to deduct the loss unless you
had poor software, or else overrode good software controls.

If it's a real estate professional that materially participates it's not passive at all so there wouldn't be an 8582. How exactly you indicate that varies from software to software, but I can see it being easy enough to check a box thinking it means one thing that actually is for real estate professional. Not impossible, at any rate.

[kamckinley]

All of the foregoing advice is good and from worthy sources. But I will add just one more factor which
may ease the pain.

You say the error occurred on the 2012 return after you reported rental losses with AGI too high. I guess my
first question is how this happened if you had good software. The software should have populated the f8582
with appropriate numbers and disallowed the loss. It would thus be impossible to deduct the loss unless you
had poor software, or else overrode good software controls.

Secondly, it is possible that these suspended losses could have been released in 2013, or maybe even 2014.
That would result in a considerable refund if 2013 can be amended. This would not cancel the penalties on
2012, but it might help if the taxpayer can have these suspended losses launched. Of course, this won't
happen if they continue to make significant income but it's worth looking into. If you took the loss in 2012,
the 2013 return would not have any knowledge of suspended losses.

Good luck. We all try to help each other on this forum.

I had mistakenly checked the "non-passive" box, so it was my fault that the software allowed it. However, I just switched from ATX to Drake this year, and based on the numerous cautions and notes that Drake provides I believe I would have caught my error had I been using Drake when this happened. Still, it was my error...

Unfortunately, income is too high in 2013 to allow any of the losses. Client will probably have to retire before their income is low enough to release any of the suspended losses, which could be a few years away.

Appreciate all the responses!