Preparer responsible for client penalty?

[Ross]

Last October a client sent me an IRS notice showing $30k in under reported income from 2018. $12k was from an early distribution 1099R and another $715 was from two W2s which I never received. Another $17k was from using 2017 W2 data instead of 2018 W2 data.

I pulled my hard copy and the 2017 W2 was stapled to their 2018 return! I am unsure how this happened. I recall they mailed me their copy of their 2017 returns along w/ their 2018 data. However, the 2018 W2 was not included. I would have noticed two W2s from the same employer for around $100k. It wasn't a downloaded W2. Did the employer mail 2017 W2s instead of 2018? Regardless, I should have noticed that it was a 2017 W2.

They paid the tax and interest due. I drafted them a letter to try and abate the $791 penalty. In December they received notice that they were still responsible for the penalty.

This morning I received an e-mail: "Jake & I have discussed this matter thoroughly, as well with others, and don’t feel we should be the ones to pay the penalty. I’m not sure how this could have happened but ultimately it was sent electronically by you which is exactly why I pay to have someone do our taxes, so that it is done correctly."

I have a day job as a financial controller and my fees are on the lower side. I am considering doing their 2020 returns for free. Being that three out of the four documents which were omitted or incorrect were never received by me, I think preparing their 2020 return for free is fair. What does the hive think?

[ATSMAN]

I have run into these type of situations where the taxpayer forgets to give me a tax document and later on claim that they had given it to me and I forgot to include that in the tax calculation.

When I get any document from a client it is scanned. I compare that to the tax organizer that they completed. Before finalizing a return I will go over the sources and if they forget to include it then it is on them. I am not responsible. I am not their mother to remember what they forgot.

I have done a 1040X to correct the error and they are responsible for tax, interest and penalty. If it is a good client I will do the 1040X for free!

So if you feel that it was your negligence you may want to make a deal with the client to split the interest and penalty, but they are responsible for the tax.

[Rapid Robert]

First item, what about your E&O insurance? Unless you fully pay the penalty out of your own pocket, I'm pretty sure by the terms of your policy you must notify them of a pending claim, even if it's below your deductible amount.

Second, yes it seems the primary W-2 error is on you. Even if you didn't notice the wrong year on the form, a review of the prior year vs current year before filing (ALWAYS do this!) would have shown suspicious identical amounts for the wage income over two years. It's pretty uncommon for an employee to be paid exactly the same wage and withholding every year, but not impossible, I suppose. As a solo practitioner, another technique I use is to always revisit every W-2 at least several days after initial data entry, to double check for typos and using my software's check-mark feature to show that I reviewed the document a second time. This is the poor person's version of "two sets of eyes".

The other two W-2s seem de minimis, not worth fighting over, except in terms of evidence of documents not provided. The 1099-R is the big question mark for me. Since it appears to be an unusual one-time event, I'd say the odds that the client did not provide it to you are pretty high, and no way you could have guessed. Have they actually provided an original paper-mailed copy of it to you now? I wonder if they signed up for paperless delivery from the account custodian and simply did not retrieve the file when they sent you their docs. Most of my clients upload docs to a portal, so I have a log of exactly which files I received and which I didn't.

Also on the 1099-R, why was there not any withholding? It is the default, and if the taxpayer explicitly chose to have no withholding, that is evidence that they knew about the income and should have noticed it was not on the return they signed.

You don't mention how long this client has been with you, or whether you care about keeping them in the future, or whether you rely on online reviews (e.g. Yelp) for business. You will have to weigh those things. The clients will probably not feel the free return prep is a fair deal if your fee is significantly lower than the penalty amount. It might be less stress to just pay the penalty (which should be deductible for you), and chalk it up to lessons learned.

Lastly, maybe not what you want to hear, but instead of having fees "on the low side", you should build in sufficient margin to cover the occasional event such as this.

[New York Enrolled Agent]

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They paid the tax and interest due. I drafted them a letter to try and abate the $791 penalty. In December they received notice that they were still responsible for the penalty.

I have no idea of the contents of your letter but let me say “there are letters” and then “there are letters”

Did you cite the IRM in your letter? Did you use reasonable cause throughout the letter? Did you use reliance on the tax preparer as an affirmative defense to have the penalty not be imposed? Did the taxpayer request an appeal?

I know I’m not answering your specific question but the quality of the requesting letter is crucial.

[Lion]

I don't have lots of clients so don't get lots of IRS letters. But I hear that it takes about three letters to the IRS to get a penalty abatement.

In fact, if the IRS did not suggest FTA, then that client may have done this during the last three years.

I agree that free tax prep is fair when they themselves contributed to their situation, but they probably do NOT. I also agree that only your % of the penalty should come from you (as free prep &/or reimbursement to them); the tax always was their liability, and they had use of that amount until they paid, so the interest is on their use of the money. Try to get the penalty abated. If not, then you have some decisions to make, as RR explained.

PS You can amend their state(s) for free.

And, did the IRS make their calculations on the missing documents, replacing the 2017 W-2 with the 2018? Or, did the IRS make their calculations on the missing documents PLUS the 2017 W-2? If the latter, then you can reduce the P&I by amending the federal return.

[TAXNJ]

A preparer’s responsibility (due diligence may or may not be questionable) did not seem to be followed thus creating an error(s) as stated.

If you have E&O insurance, contact them.

Try again to get the penalty abated.

If not abated, then consider paying the penalty (after talking to E&O).

As your client states “Jake & I have discussed this matter thoroughly, as well with others, and don’t feel we should be the ones to pay the penalty....”. This is not a good sign for your reputation.

Based on the post, doubt if client will use your services again.

[Snaggletooth]

Is it not possible to quantify how much of the penalty is due to the W-2 error, and the remainder due them ignoring information statements and not giving them to you?

Like everyone else, I make a few errors, but if I'm on the hook for unreported income because of information I never receive, I'd quit the business long ago.

[Rapid Robert]

If you have E&O insurance, contact them.

As was previously commented. If the tax pro decides to reimburse the full amount out of pocket, what's the point of contacting E&O carrier? The insurance company is not on the side of the policy holder.

[Ross]

Thanks for the replies. I do not have E & O Insurance. I do review a prior year comparison. However, the taxpayers had five W2s (actually 7 counting the two missing ones) so the prior year comparison had a $7k difference and a W2 with the same amounts as the prior year did not stand out.

They have been clients for over 10 years and live 80 miles away. I don't have any online reviews and am not worried about a negative one. I have a day job and have been doing this on the side for over 26 years. If I loose them as a client and they bad mouth me, it won't make or break me.

I do send all my clients a questionnaire in early January w/ over 60 yes/no questions. Not all clients complete the questionnaire which asked "Did you receive any distributions from an IRA or other qualified plan? If yes, please provide form(s) 1099R." They never returned the questionnaire. I only received their tax documents in the mail.

They did mail me a reissued 2018 W2 last fall. I never saw the $12k 1099R or the other small W2s totaling $715. I doubt they will be satisfied unless I pay the entire $791 penalty. The letter denying the abatement is dated 12/16 and they needed to respond by 1/10/21. They just notified me of the letter today. I believe it is too late for an appeal. She said that she tried to call the # on the letter today and cannot get through. Being she is responding late, I doubt a phone call will do any good.

[ATSMAN]

If you don't have E&O your best bet is to work out a deal with the taxpayer. Going to court will cost you a lot. If I were you I would explain to them that they have to pay the tax even if it was prepared 100% correctly on time. The issue is penalty and interest. See if you can get the penalty waived one more time otherwise settle to pay the penalty and interest. Start the negotiation at 50% because they were negligent too.

Lesson learned and now you know that you have to perhaps double verify!

[Lee Welter]

This may have been mentioned in an earlier post, but did you try First Time Abatement request with the IRS and your state taxing authority. If the taxpayer has a clean 3-year record, you may request and will be granted a First Time Abatement. For my state, the taxpayer gets this once and only once. Their record might not be clean, since the IRS already affirmed they were responsible for the penalty.

[Ross]

Can someone recommend what the letter should say to attempt to get it abated? The letter they received on 12/16 says "The information you provided didn't establish a reasonable cause to exempt you from the accuracy-related penalty. The penalty is due to a substantial understatement of income tax. Send your signed consent or explanation by Jan 10, 2021. You can also fax your consent or explanation to xxx. If we don't hear from you by that time, we'll continue to process the proposed changes to your tax return based on the information we have".

They paid the interest and tax due timely in October. I think this should help with the abatement. Thanks in advance!

[New York Enrolled Agent]

This may have been mentioned in an earlier post, but did you try First Time Abatement request with the IRS and your state taxing authority. If the taxpayer has a clean 3-year record, you may request and will be granted a First Time Abatement. For my state, the taxpayer gets this once and only once. Their record might not be clean, since the IRS already affirmed they were responsible for the penalty.

Unfortunately, FTA is restricted in its use. Based on the taxpayer’s under reporting the penalty in question is the accuracy related penalty under section 6662. This penalty cannot be abated with FTA.

[Lion]

Do you agree with the IRS calculations? Did they include both 2017 and 2018 W-2s? Run the numbers for how the return should've been filed.
Do your clients agree that they failed to include that 1099-R or refer to it in your questionnaire?
Do your clients agree that they did NOT notify you when they received IRS correspondence? Is that part of your engagement letter? (If not, add it now for 2020 returns.) What does you engagement letter say about P&I re errors?
Did YOU try to get the penalty abated? Once? Twice? Three times? Do this first.
How does your hourly rate compare to the $791 penalty your clients are asking for? Are they asking for $791 or a different amount? How many returns do you have to prepare to make up for a $791 expense?
Do you want to spend your time on the telephone and faxing letters to get the penalty abated during tax season?
Do you want to spend your time negotiating with your clients? Like Atsman, I'd start the negotiation at 50% and use the phrase contributory negligence, which they may be familiar with if they ever filed an insurance claim.
Are you going to lose these clients no matter what you do?
Do you want to keep these clients? Is it worth $791 to keep them?

[Ross]

Do you agree with the IRS calculations? Did they include both 2017 and 2018 W-2s? Run the numbers for how the return should've been filed.

I agree w/ the IRS calculations. I have not seen the 1099R, but they do recall receiving the funds. The IRS only included the 2018 W2. $88k on the 2017 W2 and $105k on the 2018 W2. There was only an additional $1k Federal withholding on the 2018 W2, so possibly they changed their exemptions.

Do your clients agree that they failed to include that 1099-R or refer to it in your questionnaire?

At this point I think they believe that I lost it. I am not sure if they are accepting responsibility for any of of this. I know I never received it or the other two W2s.

Do your clients agree that they did NOT notify you when they received IRS correspondence? Is that part of your engagement letter? (If not, add it now for 2020 returns.) What does you engagement letter say about P&I re errors?

They notified me timely in October, but not when they received the December 16th letter. I was notified yesterday via e-mail of the December 16th letter. My engagement letter says "I will prepare the return based on the records and other information you provide and as I deem necessary. As such, you are responsible for the accuracy of the information I use to prepare the returns. I am responsible for the accuracy of the returns."

Did YOU try to get the penalty abated? Once? Twice? Three times? Do this first.

No, I wrote the letter and had them sign it and mail it in along w/ a check for the tax due and interest. Do I send a letter or attempt to call? Any particular wording I should use?

How does your hourly rate compare to the $791 penalty your clients are asking for? Are they asking for $791 or a different amount? How many returns do you have to prepare to make up for a $791 expense?

I do several simple returns. Average fee is $75.

Do you want to spend your time on the telephone and faxing letters to get the penalty abated during tax season?

No, if they would have contacted me in December I would have had more time.

Do you want to spend your time negotiating with your clients? Like Atsman, I'd start the negotiation at 50% and use the phrase contributory negligence, which they may be familiar with if they ever filed an insurance claim.

It shouldn't take much time. Hopefully they will agree to 50% if the abatement is unsuccessful.

Are you going to lose these clients no matter what you do?

If I get the penalty abated I believe I will keep them. Or if I pay it all, I might keep them.

Do you want to keep these clients? Is it worth $791 to keep them?

Only if I don't have to pay part of the penalty. No, it is not worth $791 to keep them. I already have enough clients to balance with my full time controller day job.