Academic journal article Journal of Accountancy

Tax Return Preparation Mistakes: How to Avoid or Mitigate Professional Liability

Academic journal article Journal of Accountancy

Tax Return Preparation Mistakes: How to Avoid or Mitigate Professional Liability

Article excerpt

EXECUTIVE SUMMARY

* Professional liability for CPA tax preparers and other tax practitioners can arise from mistakes or omissions in preparing clients' tax returns. Courts have recognized limits on this liability, and, in many instances, tax practitioners may claim defenses and bars to legal liability.

* An amended return correcting an error may ameliorate the consequences of the error. However, taxpayers are under no legal obligation to file an amended return, so whether to do so is within their discretion. Correcting errors that involve a method of accounting generally requires permission from the IRS to make the change.

* Aside from the Tax Code and court jurisprudence, Treasury Circular 230 and AICPA Statements on Standards for Tax Services (SSTS) prescribe professional and ethical considerations and guidelines.

* Generally, tax practitioners are expected under tort law to maintain an appropriate level of professional care, skill and diligence. Taxpayers claiming that a tax preparer breached a duty must also prove that the breach was the proximate cause of their injuries.

* Not all errors necessarily give rise to actionable complaints, and plaintiffs generally may not recover as damages the correct amount of their tax liability. Related penalties may be included in damages arising from deficiencies. However, courts have split on whether interest on an underpayment may be recovered, with some allowing recovery by taxpayers. Preparers have sometimes been held liable for taxpayers' incidental costs and even, in egregious instances, for punitive damages.

* Practitioners' professional liability may be limited by any contributory negligence or actions on the part of the taxpayer, or eliminated by the applicable statute of limitations; however, the latter differs significantly among states in length and when it begins or is tolled.

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Errors and omissions in preparing tax returns can occur easily. You might accidentally enter a number incorrectly, misinterpret a law, or misconstrue the client's facts. Later, before an IRS audit, you might discover the mistake, raising gut-wrenching questions: Do you call the mistake to your client's attention? Do you advise the client to file an amended tax return? If so, by acknowledging the mistake, have you essentially conceded that you have committed malpractice? What, if anything, can you do to limit your professional liability?

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No matter when or how you become aware of a mistake, what makes it all the more exasperating is that the outcome is not within your direct control. For example, when a prior-year understatement of tax liability is discovered, notwithstanding your counsel, the client, being primarily responsible for the understatement, ultimately dictates whether to submit an amended return. A client's recalcitrance to do so may exacerbate the mistake, resulting in the client's incurring perhaps even more interest and a larger penalty. Sometimes you might even "inherit" a mistake if an error made by another preparer on a prior return has a continuing effect going forward, including on a return you are preparing.

Unfortunately, many of the foregoing error and omission discoveries are all too commonplace. In fact, in the case of one accounting malpractice insurance carrier (that is, CAMICO), tax-related claims were the most frequently encountered ("Major Risk Management Issues and Resources," IMPACT, Fall 2008).

This article examines CPAs' and other preparers' ethical duties with respect to errors and omissions. It also explores return preparers' potential malpractice damages exposure and possible legal defenses.

MISTAKES AND THE CPA's ETHICAL OBLIGATIONS

While taxpayers have a legal duty within any applicable statute of limitations to pay the correct tax, neither the IRC nor the Treasury Regulations require them to unilaterally correct tax return submission errors or omissions. …

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