Tax Preparer Penalties

The IRS (and other taxing authorities such as the Franchise Tax Board) may assess accuracy related penalties against taxpayers when taxpayers tax returns contain errors like understated income and disallowed deductions. At times, taxpayers who hired a CPA, accountant, or other tax advisor may find themselves being audited because the return their CPA or account prepared contained errors.  This blog will discuss tax preparer penalties when your accountant makes an error and when a taxpayer’s accuracy related tax penalties may be excused because due to a preparer’s error.

As I discussed in my recent Procedurally Taxing post, you must actually rely on the professional advice of an accountant or CPA.  A taxpayer whose CPA or accountant incorrectly performs clerical tasks like inputting data may not be eligible for penalty relief because these clerical tasks do not constitute tax advice.  On the other hand, a taxpayer whose CPA or accountant incorrectly advised them on the tax treatment of a complex business transaction may be eligible for penalty relief because this type of professional judgment or analysis may constitute actual advice.

Even if a taxpayer receives what could be deemed advice from their accountant or CPA, the taxpayer is not out of the woods just yet.  To be relieved of penalties, the taxpayer must show:

1. Their accountant, CPA, or tax advisor was competent;
2. They provided accurate and complete information to their accountant, CPA, or tax advisor; and,
3. They relied on the advice of their accountant, CPA, or tax advisor in good faith.

Hiring a tax professional like an accountant or CPA does not offer bullet proof protection against tax penalties.  We would recommend taking the following steps to minimize your risk of penalties.

1. Make sure your preparer is competent. Believe it or not, pretty much anyone can prepare tax returns for a living.  There are virtually no licensing requirements. That being said, make sure your preparer has the training, credentials, and experience necessary to prepare your tax return.
2. Make sure you provide your accountant with a complete and accurate tax organizer.  Keep a copy of the tax organizer and any other information you provide your accountant.
3. Let your accountant make final tax judgments. You may receive tax advice from people like financial planners, family members and other people not necessarily qualified to give you tax advice.  If you engaged supposedly “tax free” transactions, tell your accountant about them and let your accountant make the judgment as to how the transaction should be reported (or not be reported) on your tax return.  
4. Make sure you have a written record of any advice you get from your accountant. 
5. Review your return to make sure it is accurate and complete.  If you believe your CPA omitted income from your return or made some other errors, ask your CPA about it.  Keeping some sort of log of your questions like an e-mail chain can be invaluable.
6. If it is too good to be true, it probably is not true. You may not be deemed to have relied on our accountant’s advice in good faith if your accountant’s judgment calls are completely unreasonable.  Most working adults should expect to pay some tax each year.  If your tax preparer claims to be some wizard that can allow you to get away with paying zero tax year after year, there is a chance your tax preparer may be committing fraud or at the very least your tax preparer may be negligent.  Warning signs to look for include:  claiming high business deductions for businesses you do not have or do not work full time, claiming children who do not live with you as dependents, claiming income that is unreasonably low and inconsistent with your lifestyle (e.g. you have a $3,000 per month mortgage yet claimed $15,000 total income for the tax year). 

Many taxpayers should not take a do-it-yourself approach and should engage a tax professional to preparer their returns. Many taxpayers can and do obtain relief from penalties when their CPA or accountant makes a mistake. Taxpayers who prepare returns themselves and make mistakes are almost certain to incur penalties while taxpayers who rely on the advice of a competent tax professional have a good chance of avoiding penalties.

If you have found yourself in the middle of an audit or are finding yourself second guessing your accountant, we are here to help.  To learn more about tax preparer penalties contact RJS LAW  for a free consultation.

Written by Joseph Cole, Esq., LL.M.

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