Penalty Scenario

[Snaggletooth]

Client brings you a set of financial statements which have been reviewed by a CPA, but for whatever reason, he wants YOU to prepare the taxes (I don't think it matters if it is a 1120, 1065, 1120S or even a schedule C).

For many of you who don't keep up with public accounting, "reviewed" means more than just looked at. A CPA "review" is an official report, very similar to an audit except the CPA has not spent additional time digging into source documents to validate them, or performing other audit tests. The critical feature of a CPA review is a statement that the CPA has not encountered anything, in his estimation, to taint the financial statements.

The financial statements contain a balance sheet, profit/loss, cash flow, and a set of footnotes which augment the understanding of the numbers. The statements contain adequate information whereby a tax return can be filed. There are distinct line items for Revenue, cost of materials, labor, travel, and various other expenses.

You prepare the return, and it is filed.

It is later revealed that the substance of the "travel" expenses of $25,000 are simply payments to the owner with no receipts, no motels, no mileage records, or expense reports. The IRS is going to adjust the return in their favor because the company did not have an "accountable plan."

Question: Will the preparer be penalized??

[snowbird]

I would believe this would boil down to a matter of "due diligence." Did you have reason to believe the travel took place? Was the travel reasonable,ie., not a plumber traveling to Europe for business? The CPA review would be part of that due diligence ... it would says that the CPA reviewed the financials and did not become aware of any thing that did not conform to general accepted accounting prinicples ... such as taking money out as travel expense instead of a distribution. Only in an audit would the CPA go into enough detail to determine if an adequate controls were in place for travel, etc.

If the auditor is suggesting a penalty ... you can speak to his supervisor and there is an appeal avenue. See Cir 230

[outwest]

It could well be that the owner did travel...

but failed the substantiation requirements. A common scenario for the "entrepreneurial" mindset.

I don't believe you will get a cut-and-dried answer.

In the preparer's favor is the preparation from reviewed returns, much more reliable books than a Quickbooks printout. The preparer is may rely without verification on the information provided by the client. A reviewed statement is pretty good information though it has it's limitations.

On the other hand, you can't ignore the implications of client information. Travel has a number of substantiation and business purpose rules. Cruises have special rules, spousal travel has rules, and so on. Even with the reviewed statements, a tax pro would want to do some inquiry on those issues, though probably not so far as to audit the receipts.

I would note that even documented inquiry of the client may not uncover the problem.

Ex: What was the purpose of the travel? "Oh I went to the trade show and a trip to pickup some equipment and some jobs out of town." The trade show in Vegas for one day and a week spent there, the trip to Seattle for the equipment and 4 extra days with the spouse, and the out of town job at the lake 20 miles away every other week all summer. In the clients mind, it's all business 'cause his buddy does it all the time.

I would think the overall examination would also play in the analysis. Aside from this issue, how well backed up were other issues? Any technical errors? Relative to the overall return, how big was this issue? (Reviews tend to be large clients because of the expense of doing them. The $25K is small potatos relative to, say, a $3 million gross) Good results elsewhere in the examination ought to weight in the preparers favor.

No clear answer, but my gut would be that an isolated incident working off reviewed statements with at least a little inquiry won't get zinged.

[Nashville]

Rely on Taxpayer's Records

I say no penalty. If there is, then we all have to deal with an unprecedented new responsibility.

We may generally rely on the representations of the taxpayer. I do emphasize "generally" because we do have an obligation if the taxpayer tells us something that doesn't make sense.

In this case, the taxpayer has already paid handsomely for some degree of assurance with a CPA review. If the CPA was not retained to prepare taxes, analysis of the travel account might legitimately be not within the scope of his review.

Without a reason, we don't have the responsibility to audit a taxpayer. The IRS would love for us to take on this function, but this is THEIR responsibility and not ours.

[ChEAr$]

Reply

Hmmm.. to whom were you replying? to Snaggletooth? (grin)

anyway, the CPA review (you didn't say what kind it was, or which of the four main
audit letters was given the client, e..g was it an unqualified opinion? the best of the fourt?

However, if I were to prepare a return based on the information that Snaggletooth mentioned,
I really think I would be remiss if I did not inquire as to substantiation of said travel
expenses before preparing the return.

True, circular 230 says we don't have to look at each and every item, but also that we must make reasonable inquiries as to whether or not client has documentation.

So then, given no contemporaneous notes during the interview that this was done, and
should IRS beat the drums about preparer penalties.... it just might be a tough row to
hoe.

[Nashville]

Old Preparers

ChEAr$, FYI, if you're collecting them you might just add "Edsel" (Huntsville, AL) to your pseudonyms...

Last seminar I attended, a silver-haired instructor/lecturer made a point about tax preparation being an attractive occupation for young people to enter. He asked how many at the seminar were in their 20s, and a single hand went up. He then asked how many were over 50, and some 85%-90% of the room raised their hand.

He said he had done a survey, and from the best information he had, the average tax preparer was 55 years old. Of course, his audience included only perhaps the highest level preparers from HRB and JH, and most of the rest of us have our own shingle.

I don't think the IRS really cares that their enhanced penalty program may simply make the tax prep profession unattractive. For one, I would say if I were the preparer in the scenario mentioned, working from a set of statements reviewed by a CPA, and I were penalized because I didn't turn over rocks performing an audit on my client, I would consider leaving the profession.