Ethical Considerations for CPAs · 2017-06-27 · immutable – they are founded on unchanging...

Ethical Considerations

for CPAs

ETH4/17/01

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This product is intended to serve solely as an aid in continuing professional education. Due to the constantly changing nature of the subject of the materials, this product is not appropriate to serve as the sole resource for any tax and accounting opinion or return position, and must be supplemented for such purposes with other current authoritative materials. The information in this manual has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed. In addition, Surgent McCoy CPE, LLC, its authors, and instructors are not engaged in rendering legal, accounting, or other professional services and will not be held liable for any actions or suits based on this manual or comments made during any presentation. If legal advice or other expert assistance is required, seek the services of a competent professional. Revised May 2017 surgentcpe.com / [email protected] Copyright © 2017 Surgent McCoy CPE, LLC – ETH4/17/01

Table of Contents

Foundations of Accounting Ethics ............... 1 Basic Ethical Guidance for All Accountants ................................................ 2 Independence Rules for CPAs ....................... 3 Ethics and Tax Practice .................................. 4

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Foundations of Accounting Ethics

Learning objectives 1 I. Scope of This Course 1 II. Morality vs. Ethics 1

A. Impartiality Case: Good Twin, Bad Twin 2 III. Principles vs. Rules 3 IV. AICPA Code of Professional Conduct 4

A. AICPA’s Ethical Principles 5 1. Responsibilities 5 2. The Public Interest 5 3. Integrity 6 4. Objectivity and Independence 6 5. Due Care 6 6. Scope and Nature of Services 6

V. Other Sources of General Accounting Ethical Standards 7 A. Association of Government Accountants’ Ethics Handbook 7 B. Institute of Management Accountants 7 C. Public Company Accounting Oversight Board 8 D. The Institute of Internal Auditors 8

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Foundations of Accounting Ethics Learning objectives

Upon completion of this chapter, the reader should be able to: • Understand the difference between morality and ethics; • Distinguish ethical principles from ethical rules; • Identify the primary sources of ethics for accountants; and • Identify the six ethical principles contained in the AICPA Code of Professional Conduct.

I. Scope of This Course

This course is designed to explore the general ethical considerations applicable to certified public accountants (“CPAs”). As professionals, CPAs are required to maintain rigorous ethical standards by a variety of bodies, including the American Institute of Certified Public Accountants (“AICPA”)1, state societies, and licensing boards. CPAs participating in tax practice must abide by the Internal Revenue Service (“IRS”) rules as promulgated in Circular 230 and those performing audit functions for public companies must conform to Public Company Accounting Oversight Board (“PCAOB”) and Securities Exchange Commission (“SEC”) standards. Other organizations also maintain ethics codes that a CPA may be subject to, such as the Institute of Internal Auditors, the Institute of Management Accountants, and the Institute of Business Appraisers, to name only a few. While these various codes share many common traits, there are differences in emphasis and focus. This course will explore general ethical principles and rules applicable to CPAs. The contents are divided into three main topic areas: (i) general ethical guidance for all CPAs; (ii) independence and its application for audit engagements; and (iii) ethical rules related to tax practice. Although guidance is drawn from many sources (some of which are discussed separately below), the primary emphasis is on those rules contained in the AICPA Rules of Professional Conduct.

II. Morality vs. Ethics

Morality is most commonly identified with beliefs. Most of us possess beliefs about right and wrong that emanate from some real or perceived authority outside of ourselves. These beliefs are typically immutable – they are founded on unchanging principles that do not vary with the situation. As such, morality and moral values are often (but not always) connected to religious beliefs. Foundational values are those concepts or ideas, which do not by themselves constitute any one theory but which should be considered as a prerequisite to most satisfactory normative theories. These values by themselves do not constitute a justification or defense of your position; that is done through the application of a normative ethical theory. Ethics is not so much about beliefs as it is about behavior. For example, a CPA may have no moral objection to a contingent fee arrangement, but the profession’s ethical rules may prohibit such an arrangement under given circumstances. 1 The AICPA instituted a joint venture with The Chartered Institute of Management Accountants (CIMA) in 2011 that is

known as the Association of International Certified Professional Accountants.


The four general concepts that provide the foundation of a moral or ethical system are: (i) rationality; (ii) least harm; (iii) consistency; and (iv) impartiality. Rationality means that all legitimate moral or ethical acts must be supportable by generally accepted reasons. Humans are social beings, and “good” behavior must be legitimized by some form of consensus. Consensus is the foundation of rationality. The concept of least harm means that, when one must choose between evils, the moral or ethical choice is the one which produces the least evil. Moral or ethical rules, if they are valid, must be binding on all actors all the time and must be uniformly applicable, given the same relevant circumstances. Consistency has been recognized as a hallmark of virtue when a specific firm or profession interacts with the public. As such, many companies, associations, and professional organizations develop codes of ethics for their members. These codes are not so much designed to imbue the members with special moral virtue, but rather to provide for them standards of conduct so that the public can rely on a certain level of expected behavior. Finally, impartiality acts to inhibit us from treating one person different than another when there is not a good reason to do so. We set aside our personal interests in applying a code of ethics and treat all persons the same.

A. Impartiality Case: Good Twin, Bad Twin Sam and Alex have both worked for ABC Company for over forty years, having both joined the company on the very same day. Their career paths have been more or less parallel, each rising to the position of Senior Manager in their respective departments. But Sam and Alex could not be more different. Sam has a harsh management style, constantly yelling at his employees and threatening to fire them. Although Sam’s department performs well, everyone hates working for him and being assigned to his department is considered a “punishment” within the company. Even his fellow managers detest him, and if it were not for the success he has had in his department, he probably would have been fired long ago. Alex, on the other hand, is universally adored. She has a helpful and friendly management style, and everybody likes her. The success of her department is on a par with that of Sam’s and, economically at least, the company values the two managers equally. The executives of ABC have decided that it’s time to change things around, and they want to bring several “up and coming” management stars into the ranks of senior managers. To this end, they circulate a memo to both Sam and Alex, the two current senior managers who are closest to retirement. The memo emphasizes that both of their jobs are secure for as long as they like, but if they retire by the end of the year, the company will pay them a $5,000 bonus. The memo makes it clear that they should review their own special circumstances and recommends that they consult with their own legal and tax advisors if they feel it is appropriate. Without consulting with anyone, both Sam and Alex independently decided that the bonus was a good deal, so they both retired on the same day. Alex is given a big retirement party and is showered with gifts. In stark contrast, everyone is eager to see Sam leave, and Sam has made it clear that he could care less about leaving the company and is glad to be going. No one even bothers to shake Sam’s hand on his last day or bid him a fond farewell.


Alex subsequently learns that, under a relatively complex company policy that was overlooked, if they had waited just three more months to retire they would have been eligible for additional pension and healthcare benefits amounting to $20,000 a year for the rest of their lives. Alex has approached the Director of Human Resources with her dilemma. The Director came up with the idea of “re-hiring” Alex for three months so that she can receive the additional benefits. The company does not really have any work for her, but the CEO is so fond of Alex that a directive is sent out to all the departments to “find something for her to do” so that she can rectify the inadvertent mistake of retiring three months too early. This puts some strain on all the departments, but everyone is willing to put up with some inconvenience to help out Alex. Shortly thereafter, Sam discovers the same problem and finds out about the deal Alex has made. He now approaches the Director of Human Resources in an attempt to get the same deal.

Would a different response to Sam give rise to any ethical questions? Is the deal provided to Alex ethical? Would your answer change if the same deal were given to

Sam?

III. Principles vs. Rules

Codes of ethics generally contain both principles and rules. Ethical principles are designed to constitute the overall framework within which the rules are promulgated, interpreted, and applied. Principles generally deal with attitude and approach, while rules are directed at conduct. Most codes of ethics begin with a description of the basic principles upon which the rules are founded. Principles such as integrity, objectivity, independence, and competence are common with respect to ethical codes applicable to CPAs. Standing behind these principles are a series of rules that provide specific direction for behavior in specific situations. Rules generally drive the ethical process applying to accountants. In a sense, rules are easier to deal with because they tend to provide concrete, specific answers to a given practice dilemma. Principles, on the other hand, can only be utilized after the application of judgment and interpretation. This dichotomy between principles and rules should be familiar to accountants in the context of the on-going efforts at convergence between U.S. and international accounting standards. The Sarbanes-Oxley law required the SEC to conduct a study on “the adoption by the United States financial reporting system of a principles-based accounting system.” That has led to many years of study and consideration. The Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”) have been working on joint and separate projects aimed at convergence of their standards for some years, with limited success. Part of the problem is that U.S. accounting standards are generally rules-based, while international standards tend to be principles-based. This dichotomy of approaches highlights the difference between the two systems and may be instructive in understanding the difference between principles and rules on an ethics context. Some have argued that the rules-based system embodied by U.S. generally accepted accounting principles (“GAAP”) has not worked well in the past. The corporate accounting scandals of the last twenty years, some would say, are a testament to the weakness of a rules-based system for both substantive


accounting procedures and ethics. However, much of the financial reporting misdeeds technically fell within the established rules. This illuminates the basic failing of a rules-centered system. Rules are, by definition, drawn fairly narrowly and contemplate a specific set of facts or circumstances. Principles, on the other hand, tend to be crafted as fairly broad generalizations, requiring the subjective judgment of the actor in application. For this reason, those subject to standards often prefer rules. Rules take the judgment (and hence the blame) away from the actor. Furthermore, the narrowness of a rule often leaves plenty of room for variance. For this reason, principles are necessary to support the rules. We see this in many aspects of our profession – from GAAP to tax law. The Internal Revenue Code and regulations are filled with technical rules, but overlaying those rules are general concepts, such as “substance over form,” the “step transaction doctrine,” and the “tax benefit rule.” Each of these principles is intended to fill in the gaps where a strict application of the rule might bring about the types of results that the rule was designed to avoid. Because of this weakness in a rules-focused environment, our profession has gradually moved to a more principles-based perspective. The objective is to emphasize broad principles so as to eliminate the legalistic focus that rules may encourage. Arguably, this will result in a more uniform application of ethics throughout the profession. At least one study has found that CPAs are more likely to consider their independence impaired, and are more likely to reject a questionable audit engagement when principles and rules are combined in a seamless system of thought regarding ethical behavior.2 Whether this is a positive or negative development, its implications for the profession as a whole are yet to be seen.

IV. AICPA Code of Professional Conduct3

Consistent with the discussion above, the AICPA Code of Professional Conduct consists of principles, rules, and interpretations. Principles provide the framework for the rules, which govern the performance of professional services by CPAs who are members of the AICPA. The AICPA bylaws require that members adhere to the rules of the Code. While non-members are not technically subject to these rules in the AICPA Code, they form the basis of many state CPA society rules and are generally viewed as a source of ethical guidance for all CPAs. Interpretations of the rules of conduct are adopted after exposure to the membership, state societies, state boards, and other interested parties. The interpretations of the rules of conduct provide guidelines about the scope and application of the rules but are not intended to limit such scope or application. A member who departs from the interpretations, however, has the burden of justifying such departure in any disciplinary hearing. The Code of Professional Conduct was revised effective December 15, 2014. The AICPA’s Professional Ethics Executive Committee (“PEEC”) restructured the ethics standards so that members and others can apply the rules and reach correct conclusions more easily and intuitively. To achieve this, the PEEC restructured the Code into several parts each organized by topic, edited the Code using consistent drafting and style conventions, incorporated a conceptual framework for members in public practice and in business, revised certain Code provisions to reflect the “conceptual framework” approach (also known 2 Terri Harron and David L. Gibertson, Ethical Principles vs. Ethical Rules: The Moderating Effect of Moral Development on

Audit Independence Judgments, 14 Bus. Ethics Quart. 499 (2004). 3 http://www.aicpa.org/Research/Standards/CodeofConduct/Pages/default.aspx.


as the “threats and safeguard” approach) and where applicable, referenced existing non-authoritative guidance to the relevant topic. In addition, a new dynamic online platform was developed to house the Code. This platform allows users to quickly navigate the code, conduct searches, and also contains personalization features. As of 2017, a majority of states have adopted the AICPA Code or some variant of it. Only sixteen states (Alabama, Arizona, Arkansas, California, Connecticut, Florida, Georgia, Iowa, Kentucky, Louisiana, Maryland, Massachusetts, Montana, Nebraska, New York, and West Virginia) and the District of Columbia have ethics rules that are not based on the AICPA Code.

A. AICPA’s Ethical Principles The AICPA Code of Professional Conduct is guided by six specific principles:

Responsibilities; The public interest; Integrity; Objectivity and independence; Due care; and Scope and nature of services.

These are similar to principles adopted by other accounting-related organizations and will form the basis for our discussions in this course.

1. Responsibilities

The first principle of ethical behavior under the AICPA Code of Professional Conduct (responsibilities) states that CPAs should exercise “sensitive professional and moral judgments” in all of their professional activities. As professionals, certified public accountants perform an essential role in society. Consistent with that role, members of the American Institute of Certified Public Accountants have responsibilities to all those who use their professional services. Members also have a continuing responsibility to cooperate with each other to improve the art of accounting, maintain the public's confidence, and carry out the profession's special responsibilities for self-governance. The collective efforts of all members are required to maintain and enhance the traditions of the profession.4

2. The Public Interest

The public interest principle states that AICPA members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate commitment to professionalism. Our profession is one that is uniquely accountable to the public in the form of investors, creditors, employers, and regulatory agencies, among others. The public interest is defined as the collective well-being of this community of people and institutions that the profession serves. The members of this community rely on the objectivity and integrity of certified public accountants to maintain the orderly functioning of commerce. As a result, this reliance imposes a public interest responsibility on certified public accountants. The public interest principle recognizes that, in discharging their professional responsibilities, CPAs may encounter conflicting pressures from among the various groups that comprise this community. In

4 AICPA Code of Prof. Conduct, 0.300.020.


resolving those conflicts, this principle directs CPAs to act with integrity, guided by the precept that when a CPA fulfills his or her responsibility to the public, the interests of the entire community are best served.5

3. Integrity

To maintain and broaden public confidence, the AICPA ethical principles direct CPAs to perform all professional responsibilities with the highest sense of integrity.6 Integrity is about fairness and justice, and requires the CPA to be, among other things, honest and candid within the constraints of client confidentiality. Service and the public trust should not be subordinated to personal gain and advantage. Integrity can accommodate the inadvertent error and the honest difference of opinion; however, it cannot accommodate deceit or subordination of principle.7

4. Objectivity and Independence

The AICPA’s fourth ethical principle combines the concepts of objectivity and independence. It provides that a CPA should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities and that an AICPA member in public practice should be independent in fact and appearance when providing auditing and other attestation services.8 In our discussion, these two principles will be separated as the former is generally applicable to all accountants, whereas the latter applies specifically to audit and related engagements.

5. Due Care

It should go without saying that CPAs should observe the accounting profession's technical and ethical standards, strive continually to improve competence and the quality of services, and discharge professional responsibility to the best of their ability. This constitutes the AICPA’s fifth ethical principle.9 The due care required of a CPA means that the CPA must discharge his or her professional responsibilities with competence and diligence. It imposes the obligation to perform professional services to the best of his or her ability with concern for the best interest of those for whom the services are performed, and consistent with the profession’s responsibility to the public.10 Due care means paying attention to the requirements of the engagement and performing one’s services competently. Competence, in turn, does not demand perfection, but rather an honest effort to meet the technical standards involved in the engagement. Planning and adequate supervision are necessary elements of due care and competence.

6. Scope and Nature of Services

As with all professions, the breadth of the accounting profession is much too vast to be mastered by any single CPA. The AICPA’s sixth and final principle of ethics recognizes this by acknowledging that CPAs must honestly assess the limits of their abilities. To this end, the AICPA principles suggest that CPAs:

Practice in firms that have internal quality-control procedures in place to ensure that services are competently delivered and adequately supervised;

Determine, in their individual judgments, whether the scope and nature of other services provided to an audit client would create a conflict of interest in the performance of the audit function for that client; and

5 Id. at 0.300.030. 6 Id. at 0.300.040. 7 Id. 8 Id. at 0.300.050. 9 Id. at 0.300.060. 10 Id.


Assess, in their individual judgments, whether an activity is consistent with their role as professionals.11

V. Other Sources of General Accounting Ethical Standards

A. Association of Government Accountants’ Ethics Handbook12 The Association of Government Accountants’ Ethics Handbook (the “AGA Handbook”) applies to both its members and individuals who hold the Certified Government Financial Manager certificate. It provides a framework to assist in ensuring that they exercise the highest standards of professionalism and personal conduct in order to best serve the public interest. The AGA Handbook is designed to be both an aspirational standard of behavior and a guide for assisting professionals in making proper ethical decisions. Minimum expected levels of behavior are indicated, but the ethical standards are meant to constitute a framework for decision making in all circumstances. Therefore, the AGA Handbook not only sets forth rules, but it also creates an expectation of conduct within the more general framework. The public should reasonably expect that those who serve the government are trustworthy. By accepting the opportunity to serve, AGA members must also recognize the obligation to be accountable, which includes:

Becoming familiar with and abiding by the expectations, standards and rules of the position and seeking out necessary information to interpret and apply them;

Accepting personal responsibility for the foreseeable consequences of actions and inactions; and Taking into account the long-term interest of the government and its citizens.

B. Institute of Management Accountants13 Like the other bodies promulgating ethics codes, the IMA uses its Statement of Ethical Professional Practice (the “IMA Statement”) to both express aspiration principles and specific standards of conduct. The IMA's overarching ethical principles are honesty, fairness, objectivity, and responsibility. The standards of conduct are broken down into four categories: (i) competence; (ii) confidentiality; (iii) integrity; and (iv) credibility. Competence means that the professional is required to maintain an appropriate level of professional expertise, and perform his or her professional duties in accordance with all relevant laws, regulations, and technical standards. Additionally, the IMA directs its members to communicate clearly, concisely, and timely, and to recognize their professional limitations or constraints and act accordingly. Like other codes, the IMA Statement presumes confidentiality except when disclosure is authorized or legally required. Furthermore, IMA members are to inform all relevant parties regarding appropriate use of confidential information and monitor their subordinates’ activities to ensure compliance. Conflicts of interest are addressed in the context of the integrity standard. Specifically, the IMA Statements requires that the professional regularly communicate with business associates to avoid

11 Id. at 0.300.070. 12 https://www.agacgfm.org/getattachment/About-AGA/Code-of-Ethics/ethics_handbook.pdf.aspx. 13 https://www.imanet.org/insights-and-trends/business-leadership-and-ethics/ima-statement-of-ethical-professional-

practice?ssopc=1 f.


apparent and real conflicts of interest. When conflicts exist, the professional should take actions to mitigate the conflicts. In any case, all parties involved should be advised of any potential conflicts. Integrity also includes refraining from engaging in any conduct that would prejudice the professional in some way and therefore hinder his or her ability to carrying out duties in an ethical manner. Finally, integrity encompasses abstaining from engaging in or supporting any activity that might discredit the profession. With respect to credibility, each member of IMA has a responsibility to communicate information fairly and objectively, disclose all relevant information that could reasonably be expected to influence an intended user's understanding of the reports, analyses, or recommendations, and disclose delays or deficiencies in information, timeliness, processing, or internal controls in conformance with organization policy and/or applicable law.

C. Public Company Accounting Oversight Board14 The Sarbanes-Oxley Act of 200215 (“SOX”) established the Public Company Accounting Oversight Board (“PCAOB”) to oversee the audits of public companies and related matters, to protect investors, and to further the public interest in the preparation of informative, accurate, and independent audit reports. PCAOB Rule 2100 requires that each public accounting firm (including foreign firms) must register with the PCAOB if the firm either: (i) prepares or issues any audit report with respect to any issuer; or (ii) plays a substantial role in the preparation or furnishing of an audit report with respect to any issuer. The term “issuer” means a corporation or other entity the securities of which are registered under §12 of that Securities Exchange Act of 1934, or that is required to file reports under §15(d) of that Act, or that files or has filed a registration statement that has not yet become effective under the Securities Act of 1933, and that it has not withdrawn. “Playing a substantial role” includes performing material services that a public accounting firm uses or relies on in issuing all or part of its audit report with respect to any issuer or performing the majority of the audit procedures with respect to a subsidiary or component of any issuer the assets or revenues of which constitute 20 percent or more of the consolidated assets or revenues of such issuer necessary for the principal accountant to issue an audit report on the issuer. Section 103(a) of SOX specifically directs the PCAOB to establish ethics standards to be used by registered public accounting firms in the preparation and issuance of audit reports. These rules of ethics provide that a registered public accounting firm must comply with ethics standards contained in the AICPA's Code of Professional Conduct Rule 102 in connection with the preparation or issuance of any audit report. Furthermore, a person associated with a registered public accounting firm may neither take, nor omit to take, an action with the actual or constructive knowledge that the act or omission would directly and substantially contribute to a violation, the law, or the Rules of the PCAOB.

D. The Institute of Internal Auditors16 The Code of Ethics of the Institute of Internal Auditors (the “IIA Code”) states the principles and expectations governing the behavior of individuals and organizations in the conduct of internal auditing. It

14 http://pcaobus.org/Rules/PCAOBRules/Pages/Section_3.aspx#rule3500t. 15 15 U.S.C. 7202 et seq. 16 https://na.theiia.org/standards-guidance/mandatory-guidance/Pages/Code-of-Ethics.aspx.


describes the minimum requirements for conduct, and behavioral expectations rather than specific activities. As with other codes of conduct, the IIA’s code contains two components: (i) principles that are relevant to the profession; and (ii) practice of internal auditing and rules that describe behavior norms expected of internal auditors. These rules are an aid to interpreting the principles into practical applications and are intended to guide the ethical conduct of internal auditors. The IIA Code is comprised of four principles: (i) integrity; (ii) objectivity; (iii) confidentiality; and (iv) competency. The integrity of internal auditors establishes trust and thus provides the basis for reliance on their judgment. The rules involving confidentiality provide that internal auditors must perform their work with honesty, diligence, and responsibility, observe the law, and make disclosures expected by the law and the profession. Furthermore, internal auditors must not knowingly be a party to any illegal activity, or engage in acts that are discreditable to the profession of internal auditing or to the organization. Needless to say, objectivity is especially crucial in performing an internal audit. The element of independence is generally not applicable with respect to the internal audit function, which heightens the need for objectivity. To this end, the IIA Code provides that internal auditors must not participate in any activity or relationship that may impair (or be perceived as impairing) their unbiased assessment. This participation includes those activities or relationships that may be in conflict with the interests of the organization. Internal auditors are also prohibited from accepting anything that may impair or be presumed to impair their professional judgment and must disclose all material facts known to them that, if not disclosed, may distort the reporting of activities under review. With respect to confidentiality, internal auditors are instructed to be prudent in the use and protection of information acquired in the course of their duties and must not use information for any personal gain or in any manner that would be contrary to the law or detrimental to the legitimate and ethical objectives of the organization. Finally, with respect to confidentiality, the IIA Code provides that those to whom it applies must engage only in those services for which they have the necessary knowledge, skills, and experience. In addition, internal auditors must perform internal audit services in accordance with the International Standards for the Professional Practice of Internal Auditing (Standards) and continually improve their proficiency and the effectiveness and quality of their services.


Basic Ethical Guidance for All Accountants

Learning objectives 1 I. The Public Interest 1 II. Integrity 1

A. Conflicts of Interest 2 1. Conflict of Interest Case No.1: Client’s Marital Discord 3 2. Conflict of Interest Case No. 2: Succession and Estate Planning 3 3. Conflict of Interest Case No. 3: Litigation Support 4 4. Conflict of Interest Case No. 4: Performing Services for Both the Entity and Its Owners 4 5. Conflict of Interest Case No. 5: Business Transactions With Clients 5 6. Conflict of Interest Case No. 6: Competing Clients 5 7. Conflict of Interest Case No. 7: Outside Activities of CPA 5 8. Conflict of Interest Case No. 8: Referrals 6 9. Resolving Conflict of Interest Issues 6 10. Other Objectivity Impairments 7

B. Misrepresentation of Facts 8 1. Misrepresentation Case Study: Use of the CPA Designation 8

C. Subordination of Judgment 9 1. Disagreement with Superiors 9 2. Use of Third-Party Service Providers 9

III. Confidentiality 10 A. The Rule of Confidentiality 10 B. Confidentiality vs. Privilege 10 C. Common Confidentiality Dilemmas 12

1. Confidentiality Case Study No. 1: Engagement for Municipality 12 2. Confidentiality Case Study No. 2: The Feasibility Study 12 3. Confidentiality Case Study No. 3: The Joint Tax Return 13 4. Confidentiality Case No. 4: The Malpractice Suit 13

IV. Due Care and Competence 14 A. Competence Cases 15

1. Competence Case No. 1: Engagement Beyond the Scope of Expertise 15 2. Competence Case No. 2: First Time Engagement 15


Basic Ethical Guidance for All Accountants Learning objectives

Upon completion of this chapter, the reader should be able to: • Define “integrity” as it applies to accounting ethics; • Describe the ethical rules regarding resolution of conflicts of interest; • Understand the ethical implications of offering gifts to, or accepting gifts from, clients; • Understand the correct manner of using the CPA designation outside of public

accounting; and • Distinguish confidentiality rules from the legal requirements of privilege.

I. The Public Interest All professions serve the public in some way, but public accounting has a special obligation to the community at large. Accounting can reasonably be said to be a language, and it is a language in which many of its users are not fluent. These members of the public include not only clients, but also credit grantors, governments, employers, investors, the business and financial community, and others who rely on the objectivity and integrity of CPAs to maintain the orderly functioning of commerce. The role of the public accountant is to bridge the gap of communication. As such, CPAs have an obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate commitment to professionalism.1 This obligation to serve the public interest is the root of all the ethical principles that govern practice as a CPA. A genuine interest in serving the public means that CPAs will discharge their responsibilities with integrity, objectivity, and due professional care. The public interest embodies an expectation that CPAs will provide quality services and enter into reasonable and fair fee arrangements in a manner consistent with serving the public interest.

II. Integrity What is “integrity”? Integrity is often viewed as an element of character fundamental to the professions. It requires honesty and forthrightness, within the constraints of client confidentiality. It requires a subordination of personal gain and advantage to the public trust. Integrity does not require perfection; it can tolerate advertent error and differences of opinion. Deceit, however, is crowded out by integrity – the former cannot stand where the latter has taken hold. It requires adherence to both the form and the spirit of technical and ethical standards. Finally, integrity is said to be lacking whenever there is a conflict of interest, a knowing misrepresentation of facts, or a subordination of judgment. Some ethics codes also include compliance with laws and regulations as a condition of integrity. For example, the New York State Society of Certified Public Accountants Code of Professional Conduct2 specifies integrity encompasses complying with substantial provisions of federal, state, or local laws, rules or regulations governing the practice of public accountancy, as well as complying with whistle-blowing or other similar internal policies or processes, should they exist, of any organization with which the member

1 AICPA Code of Prof. Conduct, 0.300.030. 2 http://www.nysscpa.org/docs/default-source/default-document-library/nysscpa-code-of-professional-conduct.pdf?sfvrsn=0.


is affiliated, including employers, should the member become aware of any significant unethical activity, irrespective of any duty to maintain client or employer confidentiality.

A. Conflicts of Interest What constitutes a conflict of interest? Conflicts of interest encompass both actual conflicts and apparent conflicts. Because of the public nature of the CPA profession, the mere appearance of a conflict may be just as detrimental as an actual conflict, and must be avoided with the same degree of vigor. Perception is what counts, and a relationship that looks like a conflict is just as bad as one that really constitutes one. So what does “conflict of interest” mean in the context of the accounting profession? CPAs performing their standard professional services are not involved in holding of client property in trust or managing such property, so the typical fiduciary standards prohibiting self-dealing and requiring the maximization of returns does not apply. Furthermore, except in the context of dealing with the IRS or state taxing authorities, CPAs do not typically “represent” clients in an agency capacity, as do lawyers. There is a possibility that some requested professional services involving client advocacy may appear to stretch the bounds of performance standards, may go beyond sound and reasonable professional practice, or may compromise credibility, and thereby pose an unacceptable risk of impairing the reputation of the member and his or her firm with respect to independence, integrity, and objectivity. In such circumstances, the member and the member's firm should consider whether it is appropriate to perform the service. What CPAs are counted on to do is to provide an honest, objective perspective to oversee and lend credence to the work of their clients or to bring their expertise to matters that may be confounding to the lay person. Objectivity is therefore a key element of the public trust, and any circumstance that compromises, or appears to compromise, the CPA’s objectivity constitutes a conflict of interest. This principle holds true in both audit and other attestation engagements, as well as in consulting and tax preparation engagements. Therefore, a conflict of interest occurs when a CPA performs a professional service for a client or employer and the CPA (or his or her firm) has a relationship with another person, entity, product, or service that could be viewed by that client or employer (or, for that matter, other appropriate parties) as impairing the CPA’s objectivity. Objectivity is a state of mind, a quality that lends value to a member’s services. It is a distinguishing feature of the profession. The principle of objectivity imposes the obligation to be impartial, intellectually honest, and free of conflicts of interest. CPAs often serve multiple interests in many different capacities and must demonstrate their objectivity in varying circumstances. Members render attest, tax, and management advisory services as well as prepare financial statements in the employment of others, perform internal auditing services, and serve in financial and management capacities in industry, education, and government. They also educate and train those who aspire to admission into the profession. Regardless of service or capacity, members should protect the integrity of their work, maintain objectivity, and avoid any subordination of their judgment. All members have the responsibility to maintain objectivity in rendering professional services. Members employed by others to prepare financial statements or to perform auditing, tax, or consulting services are charged with the same responsibility for objectivity as


members who perform attest services and must be scrupulous in their application of generally accepted accounting principles and candid in all their dealings with members who perform external attest services.

1. Conflict of Interest Case No.1: Client’s Marital Discord Chris is a CPA who has provided tax planning services to Jim and Jill Smith for a number of years. The Smiths’ return has been audited by the IRS, and it was discovered that Jim was not reporting a significant amount of income from his restaurant business, unbeknownst to Jill. Needless to say, marital discord ensues, resulting in Jim and Jill’s separation. Both of them ask Chris to continue providing the same services to them on a separate basis.

What objections might Jill have to Chris’s continuing to give tax planning advice to Jim? Might Jim have any objections to Chris’s continued professional relationship with Jill? Would it make a difference if the separation was amicable or hostile? Could Chris avoid both an actual conflict and the appearance of a conflict? What if one or both parties ask Chris to testify in the divorce proceeding regarding the family’s

financial matters? Could Chris testify for one of them, but not the other? Would a court have any questions about Chris’s objectivity?

Aside from the potential conflicts involving the two parties, suppose Jim insists that Chris aided him in the non-disclosure of his income. Would that impair Chris’s objectivity vis-à-vis Jim? If Chris advises Jill regarding the possibility of innocent spouse relief, has his objectivity been impaired?

Marital disruptions give rise to many issues, especially when a small business is involved. Since significant legal issues are involved, it is imperative that both spouses be advised to retain their own legal counsel. Note that the conflict of interest rules governing lawyers would generally prohibit the same lawyer or law firm from representing both parties. Given this, would a conflict result if the CPA were to refer one of the parties to a specific attorney? Could Chris refer Jim to the person he considers to be the “best divorce lawyer in town” without stepping into a conflict? Would doing so impair Chris’s integrity?

2. Conflict of Interest Case No. 2: Succession and Estate Planning

CPAs working with attorneys, investment advisors, and other professionals in multi-generational tax planning situations may encounter disputes over division of property, ownership of businesses, and charges of either favoritism or conflicts of interest from disgruntled beneficiaries. Although it may be preferable for all parties of the planning engagement to be represented by independent professionals, this may not be practical due to cost factors and other realities of the professional environment. CPAs should have a clear engagement letter that outlines their responsibilities in any planning situation. The engagement letter should explicitly detail whether the CPA firm is assuming the primary responsibility for the planning or is merely acting in an ancillary or secondary team role to other professionals. The CPA firm should fully disclose potential conflicts of interest and secure written approval from all parties if it undertakes to represent multiple parties in the transaction. All engagement letters or contracts should clearly specify for whom the practitioner is working and to whom information may be disclosed. Insurance companies often discourage CPAs who represent more than one party in a succession or estate planning engagement from completing the tax return for any beneficiary. Since the CPA has access to personal financial information that could be used to the beneficiary's disadvantage, a conflict of interest may arise. If so, both the CPA firm and the attorneys may be named in a liability claim for not fully disclosing the details of the succession plan or will. While the realities of practice may preclude such


representation, the CPA should secure written permission from the client to engage in such work. The CPA should also keep written records of any discussion with the clients.

3. Conflict of Interest Case No. 3: Litigation Support ABC Company has been a long-time tax client of Smith & Jones, CPAs. The CPA firm has also conducted annual audits for XYZ Corp. for the past four years, but this year XYZ rotated its audit firm in accordance with company policy. ABC and XYZ have entered into a contract under which XYZ is to pay ABC a royalty based on the profits generated by a specific operating unit that XYZ acquired from ABC a few years ago. ABC believes that XYZ has been understating its profits from the operating unit for some time, and consequently, breaching its contract to pay royalties.

Assuming the alleged understatement was not material and would not have affected the prior audit opinions of Smith & Jones, may a partner at Smith & Jones testify as an expert witness for ABC in its litigation with XYZ?

What potential concerns or objections might Smith & Jones have? Would it make a difference if the partner has recently left Smith & Jones to establish her own

consulting firm?

Under Rule 301, this situation produces a conflict of interest if any part of the subject matter of the suit relates in any way to the work the accountant performed for the former client. In addition, if the accountant's knowledge of the former client was gained through the former practitioner/client relationship, and could be used to disadvantage the former client, a conflict of interest arises.3

4. Conflict of Interest Case No. 4: Performing Services for Both the Entity and Its Owners Ronnie is a CPA who was recently engaged to prepare the Form 1065 Partnership Tax Return for a new client called DEF, LLC. The partners of DEF are David, Edna, and Frank. Edna and Frank have subsequently approached Ronnie to prepare their individual tax returns.

Should Ronnie have any ethical concerns regarding the preparation of the individual returns for Edna and Frank?

Would these concerns be eliminated if only one partner asked Ronnie to prepare his or her individual return?

Even if the partnership and each of the partners give “knowledgeable consent” for the practitioner to prepare these returns, it is questionable whether Ronnie can keep confidential the information provided by each of the separate parties. Also, conflicts of interest can arise in other areas related to pass-through entities. For example, while depreciation and inventory methods elections are made at the entity level, such elections affect the individual or business tax returns of all owners. Thus, the individual owners might have opposing interests in the selection of these methods. Ronnie might be accused of making elections that favored Edna and Frank to the detriment of David. In his capacity of preparing the DEF Form 1065, Ronnie is employed by the entity, and not by the owners of the entity. Decisions regarding elections should be governed by the ownership agreement and should be made by the owners, not by Ronnie. Of course, the owner may need to be educated in this regard and Ronnie should explain the election to them and document both the disclosure and the decision.4

3 AICPA Code of Prof. Conduct, 1.700.001. 4 AICPA Code of Prof. Conduct, Interpretation 102-2.


5. Conflict of Interest Case No. 5: Business Transactions With Clients

In addition to her CPA practice, Jill has opened an electronics store in her small town. Due to the distance of the “big box” stores from the town, Jill’s store has become very popular and has a steady flow of customers. Jill can hardly keep the shelves stocked and her employees are constantly turning away customers because they run out of merchandise. The problem is that Jill does not have enough capital to increase her inventory. In connection with a PFP engagement, Jill’s client Russ tells her that he is very entrepreneurial and not at all risk adverse. Furthermore, Russ is very interested in investing in local businesses and asks Jill about any “venture capital” investment opportunities within the local business community. After investigating several local businesses and coming up with no attractive alternatives, Jill concludes that her electronics store would fit Russ’s requirements perfectly.

Can Jill suggest to Russ that he invest in her electronics store? Is there anything Jill can do to ameliorate any ethical problems she might have in this regard?

6. Conflict of Interest Case No. 6: Competing Clients

CPA Joan is a partner in the firm of G&H CPAs. Joan also owns 20 percent of the stock of Sopwith Camel Air, a small commuter airline that flies out of the local airport. Two other individuals each own 40 percent of the stock, respectively, of Sopwith. Commuter Air, a competitor of Sopwith, has approached G&H about a consulting services engagement. The consulting services to be provided by G&H would all be rendered by one of Joan’s partners, and not Joan.

Can G&H accept the consulting engagement with Commuter Air? Would your answer be different if Joan owned 60 percent of Sopwith? Would your answer be different if Joan would be personally involved in the Commuter Air

engagement?

Suppose Commuter Air does not want an on-going consulting agreement, but instead is going out of business and intends to sell its terminal location at the airport. Sopwith may (or may not) be interested in purchasing the location. Commuter Air approaches G&H about performing a valuation of the real estate.

Should G&H have any ethical concerns about the valuation engagement? If so, is there any way these concerns could be eliminated?

7. Conflict of Interest Case No. 7: Outside Activities of CPA CPA Bob serves as a director of a local United Way organization that operates as a federated fund-raising organization from which local charities receive funds. Some of those charities are clients of Bob’s firm.

Does this present a conflict of interest for Bob?

Suppose Bob serves on the city’s board of tax appeals. Several of Bob’s tax clients have matters pending before the board of tax appeals.

Does this present a conflict of interest for Bob?

A conflict of interest may occur if a CPA performs a professional service for a client and the CPA has a relationship with another entity that could be viewed by the client or other appropriate parties as impairing the CPA’s objectivity. If Bob believes that he can perform professional services for the charities that receive United Way funds with objectivity and the relationship is disclosed and consent is obtained from


the appropriate parties, performance of the service is not prohibited.5 His role as a decision maker on the board of tax appeals raises another issue entirely. The ethical rules of the board may be more of a relevance to that of the accounting profession in this case.

8. Conflict of Interest Case No. 8: Referrals

Janet is a CPA with both tax and PFP practice. She and her family also own a commercial real estate brokerage firm. One day Janet has lunch with George, an insurance broker who has just opened an office in Janet’s building. Janet has never had any dealings with George, and knows nothing about him, other than what she learns at lunch. However, she is impressed with George’s apparent knowledge of the insurance industry and his eagerness to build his business. He tells Janet that he will guarantee at least one tax or PFP referral to her for each person she refers to him for insurance products. Later that day Ken meets with Janet regarding some financial matters. Ken has been a client of Janet’s for a couple of years, but she has only prepared tax returns for him in the past. Now Ken wants Janet‘s assistance in his personal financial planning. He is also looking for a new location into which to move his own business. Janet suggests that Ken meet with George and she calls George to set up an appointment for Ken while he is still in her office. She also refers Ken to her family’s real estate brokerage for help in finding a new business location.

Does the referral to George present any ethical problems for Janet? Would it change your answer if Janet just suggested George to Ken and did not make the

appointment? Does the referral of Ken to her family’s real estate business cause a conflict of interest? Would your answer change if the real estate business belonged to her husband’s family and she

did not have any other connection with it? What could Janet do to alleviate any potential ethical concerns with regard to both referrals?

9. Resolving Conflict of Interest Issues

A CPA may proceed with an engagement despite the presence of a conflict of interest if three requirements are met.6

a. First, the CPA must be satisfied that the professional service can actually be performed with objectivity, despite the conflict. A CPA has to make an honest assessment of the facts and circumstances surrounding the engagement and conclude, in good faith, that his or her objectivity will not be impacted by the conflict or potential conflict.

b. If the CPA believes that the professional service can be performed with objectivity, the CPA must disclose the relationship giving rise to the conflict to the respective parties involved. While there is no specific requirement that written notification be given, this is of course always a good idea.

c. Finally, assuming the CPA has concluded that the services can be performed with objectivity and the relationship giving rise to the conflict has been disclosed, the CPA must obtain consent from such client, employer, or other appropriate parties. Again, it is not required, but strongly recommended, that this consent be obtained in writing.

If all three of these requirements are complied with, the rule shall not operate to prohibit the performance of the professional service. Certain professional engagements, such as audits,

5 AICPA Code of Prof. Conduct, 1.110.010. 6 AICPA Code of Prof. Conduct, Interpretation 102-2.


reviews, and other attest services, require independence. Independence impairments cannot be eliminated by such disclosure and consent.

10. Other Objectivity Impairments a. Gifts. Objectivity or integrity may be considered to be impaired if a CPA offers or accepts

gifts or entertainment to or from a client. The same is true if the CPA offers or accepts gifts or entertainment to or from an individual in a key position with a client or an individual owning 10 percent or more of the client's outstanding equity securities or other ownership interests. Furthermore, the same concept applies if a customer or vendor of the CPA's employer (or a representative of the customer or vendor) is involved.7

Objectivity would be considered to be impaired unless the gift or entertainment is reasonable in the circumstances. The CPA must exercise his or her judgment in determining whether gifts or entertainment would be considered reasonable in the circumstances. Relevant facts and circumstances should include, but are not limited to: (i) The nature of the gift or entertainment; (ii) The occasion giving rise to the gift or entertainment; (iii) The cost or value of the gift or entertainment; (iv) The nature, frequency, and value of other gifts and entertainment offered or

accepted; (v) Whether the entertainment was associated with the active conduct of business

either directly before, during, or after the entertainment; (vi) Whether other clients, customers, or vendors also participated in the

entertainment; and (vii) The individuals from the client, customer, or vendor and the member's firm or

employer who participated in the entertainment.

In addition, a member would be presumed to lack integrity if he or she accepted or offered gifts or entertainment that he or she knew, or was reckless in not knowing, would violate the member, client, customer, or vendor's policies or applicable laws and regulations.8

b. Services Requiring Judgment. The integrity principle comes into play in virtually every aspect of the accountant's professional practice, but among the more important service areas in which it may be encountered is in rendering accounting judgments when the technical rules are complex or vague, or where estimation is called for. It is in those areas that management may have a wide berth to affect the reported results of an entity. Accordingly, an accountant should exercise considerable vigilance with respect to such items on the financial statements. These are just a few examples that may implicate significant judgment or discretion: (i) Judgments concerning the length of the useful life of an asset for purposes of

determining the proper estimate to use in recording depreciation; (ii) Estimates of uncollectible accounts, which are often predicated on judging the

likelihood of collection of receivables; and (iii) Estimates of warranty expense based on past experience and projected future

conditions.

7 AICPA Code of Prof. Conduct, 1.120.010. 8 Id.


Each of these examples involves an accounting estimate that can be highly judgmental, and can significantly affect a company's financial statements. The CPA may be faced with a professional judgment with no objectively correct answer. Instead, he or she must make a professional judgment consistent with the underlying values of honesty and integrity under all the circumstances.

B. Misrepresentation of Facts Knowingly misrepresenting facts can come in a variety of forms. For example, if a CPA makes (or permits or directs another to make) entries in an entity’s financial statements that he or she knows, or should know, are materially false and misleading, the CPA has acted with an absence of integrity.9 The phrase “knows, or should know” means that both either or constructive knowledge will suffice. “Constructive knowledge” refers to being cognizance of circumstances and making those inferences that any reasonable person would make in a similar situation. CPAs acting with integrity cannot hide their heads in the sand and ignore the obvious implications of the facts and circumstances in which they find themselves. Furthermore, when a CPA becomes voluntarily associated with information that is materially false or misleading, he or she has compromised his or her integrity. For example, if a CPA signs (or permits or directs another to sign) a document containing materially false and misleading information, they are acting with an absence of integrity. In dealing with his or her employer's external accountant, a CPA must likewise be candid and not knowingly misrepresent facts or knowingly fail to disclose material facts. This would include, for example, responding to specific inquiries for which his or her employer's external accountant requests written representation.

1. Misrepresentation Case Study: Use of the CPA Designation

Phil is a CPA with an active license in his state. However, rather than working in public accounting, he is the controller of a small business. Phil’s business cards and letterhead clearly indicate that he is the controller of the business, but also indicate that he is a CPA.

Does Phil’s use of the CPA designation on his business card and letterhead present any ethical issues?

Generally, a licensed CPA is allowed to indicate his or her professional status, even if acting in a private capacity outside of public accounting. However, if the CPA designation is used in a manner to imply that he or she is independent of the employer or the private business, the CPA may be deemed to be knowingly misrepresenting facts. Therefore, it is advisable that in any transmittal within which a licensee uses his or her CPA designation, he or she clearly indicates the employment title.10 In appropriate circumstances, the CPA may want to include a written disclaimer that the material is not being provided in his or her capacity as a CPA and that no independent review or other procedure is being asserted.

9 AICPA Code of Prof. Conduct, Interpretation 102-1. 10 Id. at 501.112.


C. Subordination of Judgment

1. Disagreement with Superiors

As a professional, the CPA has a unique relationship with his or her superiors. A licensed CPA is presumed to use his or her own professional judgment and cannot simply follow the incorrect direction of a superior. At the same time, of course, employment relationships may be sensitive, and the ethical rules do not require a CPA to jeopardize his or her job every time he or she has a disagreement with a superior. If a CPA and his or her supervisor have a disagreement or dispute relating to the preparation of financial statements or the recording of transactions, the CPA should take the following steps to ensure that the situation does not constitute a subordination of judgment:

a. The subordinate CPA should consider whether: (i) the entry or the failure to record a transaction in the records; or (ii) the financial statement presentation or the nature or omission of disclosure in the financial statements, as proposed by the supervisor, represents the use of an acceptable alternative and does not materially misrepresent the facts. If, after appropriate research or consultation, the CPA concludes that the matter has authoritative support and/or does not result in a material misrepresentation, he or she need do nothing further.

b. If the subordinate CPA concludes that the financial statements or records could be materially misstated, the subordinate CPA should make his or her concerns known to the appropriate higher level(s) of management within the organization (for example, the supervisor's immediate superior, senior management, the audit committee or equivalent, the board of directors, and/or the company's owners). The subordinate CPA should consider documenting his or her understanding of the facts, the accounting principles involved, the application of those principles to the facts, and the parties with whom these matters were discussed.

c. If, after discussing his or her concerns with the appropriate person(s) in the organization, the subordinate CPA concludes that appropriate action was not taken, he or she should consider his or her continuing relationship with the employer. The CPA also should consider any responsibility that may exist to communicate to third parties, such as regulatory authorities or the employer's (former employer's) external accountant. When the CPA feels compelled to take this action, he or she should first consult with his or her legal counsel.11

2. Use of Third-Party Service Providers

Assume a CPA in public practice uses a third-party service provider in the context of an engagement. A third-party service provider is an entity that the CPA, individually or collectively with his or her firm or with members of his or her firm, does not control, or an individual not employed by the CPA. Third-party service providers are often used to assist in providing professional services to clients, such as bookkeeping, tax return preparation, consulting, or attest services, including related clerical and data entry functions to clients. Because the concept of integrity requires a CPA to be honest and candid, disclosure will have to be made in most cases to the CPA’s clients. Clients might not have an expectation that their CPA would use a

11 AICPA Rules of Prof. Conduct, Interpretation 102-4.


third-party service provider to assist in providing the professional services. Accordingly, before disclosing confidential client information to a third-party service provider, a CPA should inform the client, preferably in writing, that he or she may use a third-party service provider. If the client objects to the use of a third-party service provider, the CPA should provide the professional services without using the third-party service provider or decline the engagement.12 Note, however, that a CPA is not required or expected to inform the client when he or she uses a third-party service provider to provide administrative support services. Administrative support services include things like record storage, software application hosting, or authorized e-file tax transmittal services.

III. Confidentiality

A. The Rule of Confidentiality The AICPA Code of Professional Conduct Rule 301 provides that a CPA may not disclose any confidential client information unless the client specifically requests it.13 There are four principal exceptions to this rule.

(i) The first is if disclosure of confidential information is necessary in order for the CPA to comply with his or her obligations to follow GAAP or other applicable substantive standards.

(ii) The second, and perhaps most common exception, is where disclosure is necessary in order for the CPA to comply with a validly issued and enforceable subpoena or summons, or to permit the CPA’s compliance with applicable laws and government regulations.

(iii) Furthermore, the confidentiality rule is not construed so as to prohibit review of the CPA’s professional practice under the AICPA or state CPA society or Board of Accountancy authorization (i.e., peer review).

(iv) Finally, the confidentiality rule is not intended to preclude a CPA from initiating a complaint with, or responding to any inquiry made by, any duly constituted investigative or disciplinary body the jurisdiction of which the CPA is subject.

B. Confidentiality vs. Privilege Confidentiality is not the same as the accountant-client privilege. Confidentiality is a standard under which the accountant is obligated to refrain from disclosing information relating to a client that the accountant obtains in the course of his or her representation. Many states have adopted accountant confidentiality statutes.14

12 AICPA Code of Prof. Conduct, ET 1.700.001. 13 Id. 14 Alabama (Ala. Code §34-1-21(a)); Alaska (Ala. Stat. Ann. §08.04.662); Arizona (Ariz. Rev. Stat. Ann. §32-749); Colorado

(Colo. Rev. Stat. Ann. §13-90-107(1)(f)(I)); Connecticut (Conn. Gen. Stat. §20-281j); Delaware (24 Del. Code §120); Hawaii (Haw. Rev. Stat. §466-12); Illinois (225 Ill. Comp. Stat. Ann. §450/27); Indiana (Ind. Code Ann. §25-2.1-14.1; Iowa (Iowa Code Ann. §542.17); Kansas (Kan. Stat. Ann. §1-401); Kentucky (Ky. Rev. Stat. Ann. §325.440; Maine (Me. Rev. Stat. Ann. tit. 32, §12279); Maryland (Md. Code Ann., Cts. & Jud. Proc. §9-110; Massachusetts (Mass. Gen. Laws Ann. ch. 112, §87E); Michigan (Mich. Stat. Ann. §339.732; Minnesota (Minn. Stat. §326A.12); Mississippi (Miss. Code Ann. §73-33-16); Missouri (Mo. Ann. Stat. §326.322; Montana (Mont. Code Ann. §35-50-402); New Hampshire (N.H. Rev. Stat. Ann. §309-B:18); New Jersey (N.J. Stat. Ann. §45:2B-65); New Mexico (N.M. Stat. Ann. §38-6-6(c)); North Dakota (N.D. Cent. Code §43-02.2-16); Oregon (Or. Rev. Stat. §673.385); Pennsylvania (63 Pa. Cons. Stat. Ann. §9.11a); Rhode Island (R.I. Gen. Laws §5-3.1-23); South Carolina (S.C. Code Ann. §40-2-190); Tennessee (Tenn. Code Ann. §62-1-116); Vermont (Vt. Stat. Ann. tit. 26, §82); Washington (WA Rev. Code Ann. §18.04.405); Wisconsin (Wis. Stat. Ann. §.442.13).


The accountant-client privilege, on the other hand, is a matter of evidentiary law that prohibits a plaintiff (or the state) from eliciting testimony from a CPA regarding certain matters. Specifically, it is a legal right belonging to the client that can only be waived by the client. A CPA who discloses privileged communication has not only violated ethical standards but has transgressed the law, which could entail serious legal consequences. While state confidentiality statures vary a great deal, the obligation of confidentiality generally applies to all information a CPA receives from his or her client, even, some would argue, the very identity of the client. Note, however, that it is generally permissible for a CPA to disclose the name of a client, whether publicly or privately owned, without the client’s specific consent unless the disclosure of the client’s name constitutes the release of confidential information. For example, if a member's practice is limited to bankruptcy matters, the disclosure of a client's name would suggest that the client may be experiencing financial difficulties, which could be confidential client information.15 To make matters more confusing, some states have statutory confidentiality language that also refers to the information as being “privileged.” Where this is the case, it is unclear what the legislature intended by using the term ‘‘privileged’’ in reference to the information. It may or may not mean that an accountant-client privilege exists. The accountant-client privilege, unlike client confidentiality, is very narrow, and its specific scope depends on the law of the applicable jurisdiction. Federal law, for example, provides for a very limited accountant-client privilege. Federal accountant-client privilege is restricted to non-criminal (i.e., civil) tax matters litigated in federal court, and it does not apply to any communications regarding corporate tax shelters.16 State laws vary with respect to recognition of accountant-client privilege, and some states do not recognize it at all. Among the states that statutorily recognize the privilege are California, Florida, Georgia, Idaho, Louisiana, Nevada, and Oklahoma.17 As under federal law, some specifically provide that the privilege does not apply to criminal prosecutions. In some states, the laws specifically provide that the privilege does not protect a disclosure to law enforcement if the accountant has a reasonable basis for believing that the client violated federal, state, or local laws. Other states, such as Indiana, Georgia, Missouri, Pennsylvania, Tennessee, and Texas, do not specifically restrict the application of privilege to non-criminal (i.e., civil) tax matters. As a result, CPAs are often confused about what rules apply when trying to determine or comply with their obligations of confidentiality and privilege. A CPA may receive requests for information about a client from many different sources. When a CPA receives a written or oral request for information or records regarding a tax client from a non-governmental party, the CPA should generally refuse them without the client’s written consent. If the client has given written permission to the CPA authorizing him or her to release the information, the CPA may do so with confidence. Even IRS agents are not entitled to confidential information without a subpoena or court order.

15 AICPA Code of Prof. Conduct, 1.700.090. 16 26 U.S.C. 7525. 17 California (Calif. Revenue and Taxation Code §7099.1); Florida (Fla. Stat. Ann. §90.5055); Georgia (Ga. Code Ann. §43-

3-32(b)); Idaho (Idaho R. Evid. 515); Louisiana (La. Rev. Stat. Ann. §37:86; La. Code of Evid. Art. 515); Nevada (Nev. Rev. Stat. Ann. §49.185); Oklahoma (Okla. Stat. Ann. tit. 12, §2502.1).


Subpoenas are a method by which a party to litigation (or sometimes a grand jury) requests information from a third party. A subpoena may seek only documents or may request a deposition as well. Although subpoenas issued by attorneys appear formal, not all subpoenas are valid or enforceable. A CPA should always consult with legal counsel before responding to a subpoena regarding client information.

C. Common Confidentiality Dilemmas Divorce. Divorcing clients always raise the specter of confidentiality problems. Even amicable divorce proceedings can become contentious, and the CPA must ensure that no confidential information is communicated to parties in violation of client confidentiality. CPAs must clearly identify for whom they are working in such situations. They should not distribute any client information without permission unless required to do so by law. Practitioners are also advised to consult their own legal counsel to determine if the divorce context places them in a fiduciary capacity under federal or state law or requires the CPA to involuntarily disclose information. Bank Directorships Held By CPAs. Before accepting a bank directorship, a CPA should carefully consider the implications of such service if he or she has clients that are customers of the bank. This may give rise to confidentiality issues. A CPA in public practice must not disclose any confidential client information without the specific consent of the client. This ethical requirement applies even though failure to disclose information may constitute a breach of the member's fiduciary responsibility as a director.18

1. Confidentiality Case Study No. 1: Engagement for Municipality

RSQ & Company, CPAs practice in Metropolis. The City of Metropolis has a personal property tax on business inventories, fixtures and equipment, and machinery. The city enforces this tax by retaining a CPA firm to examine the books and records of the businesses to be sure the proper amount has been declared. This year Metropolis has hired RSQ & Company. In the course of its engagement, the CPA firm will examine sales, purchases, gross profit percentages, and inventories as well as fixed asset accounts. Terry Price, CPA provides services to one of the companies involved in the audit. Terry objects to these procedures on the ground that information gathered from the books and records of his client could be inadvertently conveyed to competitors by employees of RSQ & Company.

Does Terry have a legitimate ethical complaint against RSQ & Company?

In this case, there would be no ethical rule prohibiting RSQ & Company from taking the engagement. It should, however, be emphasized to everyone concerned that ethical rules do prohibit RSQ & Company or any of its employees from revealing to others any confidential information obtained in their professional capacity.

2. Confidentiality Case Study No. 2: The Feasibility Study

In the course of performing a feasibility study, a nonclient outside source has provided pertinent information to A&B CPAs with the understanding that the source and the details of the information will not be disclosed. The information, which A&B believes is pertinent, directly affects its conclusions and recommendations.

How, if at all, may this information be utilized in connection with the feasibility study engagement and related conclusions and recommendations?

18 AICPA Code of Prof. Conduct, 391.035 et seq.


The confidentiality ethics rule is not directly applicable to the circumstances described because confidential client information is not involved (the outside source is identified as a nonclient). However, for an engagement in which it appears likely that the development of pertinent information will have to come from outside nonclient sources, and such information must remain confidential, the terms of the engagement with the client should specify that the confidences of outside nonclient sources will not be divulged, even when they might affect the outcome of the engagement. If the use of confidential outside sources is necessary and the terms of the engagement are silent regarding disclosure of source and details, A&B should promptly seek the approval of the client to present his or her recommendations without making disclosures that include confidential information. If the client does not agree to this, A&B should withdraw rather than breach a confidence or improperly limit the inclusion of information in their final recommendation.19

3. Confidentiality Case Study No. 3: The Joint Tax Return

Phyllis Samuals, CPA has prepared Ken Smith’s tax returns for many years, including several years before he was married. After Ken got married, Phyllis prepared the joint return of Ken and his wife Kathy for several years, but Phyllis has never met, or even spoken to, Kathy. Divorce proceedings are now under way and Kathy Smith has approached Phyllis with requests for confidential information relating to prior tax returns. Ken has directed the member not to comply with Kathy’s requests.

Who is Phyllis’s client? Ken? Kathy? Both? If Phyllis releases this information to Kathy, would Phyllis be violating her obligation of

confidentiality? What, if anything, should Phyllis do before complying with Kathy’s request? Could Phyllis have done anything at the beginning of the engagement to avoid this problem?

When a CPA prepares a joint tax return, both spouses are considered to be the CPA’s client, even if the CPA has a prior relationship with one spouse or only has contact with one spouse. Therefore, the release of the requested information to Kathy would not be prohibited by the rules of confidentiality. Since Ken objects and might attempt legal action against Phyllis, however, Phyllis would be well advised to seek legal counsel.20

4. Confidentiality Case No. 4: The Malpractice Suit

Sally Slow, CPA has learned of a potential claim for malpractice that may be filed against her by Joe Smith, one of her tax clients. Sally’s professional liability insurance policy requires that the carrier be promptly notified of any actual or potential claims. Upon notifying her carrier of the potential claim, the carrier has requested additional information and documents that contain confidential client information regarding Joe.

Does Sally have to seek Joe’s permission before disclosing the information to her malpractice insurance carrier?

If Joe commences a suit against Sally, is Sally prohibited from testifying about facts related to her engagement due to the accountant-client privilege?

The confidentiality rule is not intended to prohibit a member from releasing confidential client information to the member's liability insurance carrier solely to assist the defense against an actual or potential claim

19 Id. 20 Id.


against the member. Sally may disclose such information to her insurance company without Joe’s permission.21 Although the scope of the accountant-client privilege varies depending on the jurisdiction, it is universally deemed to be waived if the client sues the accountant for malpractice. Sally could freely testify in the proceeding without danger of violating the accountant-client privilege.

IV. Due Care and Competence Part and parcel of performing a professional service ethically is performing it competently. The ethical obligation of due care requires a CPA to discharge his or her professional responsibilities with competence and diligence. CPAs have an obligation to perform professional services to the best of their ability with concern for the best interest of those for whom the services are performed and consistent with the profession's responsibility to the public. A CPA's agreement to perform professional services implies that the CPA has the necessary competence to complete those professional services according to professional standards, applying his or her knowledge and skill with reasonable care and diligence, but the member does not assume a responsibility for infallibility of knowledge or judgment. Competence evolves from a combination of education and experience. At its root is a working familiarity with a common body of knowledge and the maintenance of, and enhancement of, that state through a commitment to learning and professional improvement that must continue throughout the CPA’s professional life. The objective is to maintain a level of competence that will assure a high level of professionalism in performing services for our clients. It is also important that a professional recognizes his or her limitations. Our ethical commitment to the public requires that consultation or referral should be undertaken when a CPA is involved in, or asked to perform, a professional engagement that exceeds the personal competence of the CPA. Each member is responsible for assessing his or her own competence and for making appropriate decisions regarding the undertaking of the task or referral to another. A CPA may have the knowledge required to complete the services in accordance with professional standards prior to performance. In some cases, however, additional research or consultation with others may be necessary during the performance of the professional services. This does not ordinarily represent a lack of competence, but rather is a normal part of the performance of professional services. However, if a member is unable to gain sufficient competence through these means, the CPA should suggest, in fairness to the client and the public, the engagement of someone competent to perform the needed professional service, either independently or as an associate. Competence extends to the entire engagement, and includes a CPA’s obligation to monitor the competence of subordinates and subcontractors. When selecting subcontractors, the member has a responsibility to ensure that the subcontractors have the professional qualifications, technical skills and other resources required. Factors that can be helpful in evaluating a prospective subcontractor include: (i) business, financial and personal references from banks, from other CPAs, and from other customers of

21 Id. at 1.700.001.


the subcontractor; (ii) the subcontractor's professional reputation and recognition; (iii) published materials (articles and books authored); and (iv) the member's personal evaluation of the subcontractor.22

A. Competence Cases

1. Competence Case No. 1: Engagement Beyond the Scope of Expertise

CPA Pat Smith is an experienced tax preparer who diligently follows developments in the tax law and provides top quality tax preparation services. Pat is proud to observe that, in ten years of practice, none of her clients has ever been audited by the IRS. That is until this year, when one of her corporate clients received an audit letter. At the request of the client, Pat met with the IRS revenue agent and provided all of the material requested. The revenue agent and Pat disagreed about the application of a technical provision in the tax code and, as a result, a notice of proposed adjustment was issued. Although Pat is confident in the correctness of her position, she has been unable to convince the revenue agent and is unsure what additional steps to take.

Should Pat continue the representation or refer her client to someone else?

2. Competence Case No. 2: First Time Engagement

CPA Chris Jones has been doing general bookkeeping and write-up work, as well as compilations and reviews, for several years. He also prepares tax returns for his small business clients. Today one of his clients called and asked Chris to help him with regard to the purchase of a franchise donut shop. The client says he has retained a lawyer and that the lawyer said they need an experienced CPA on board to handle the accounting and tax issues. Chris has never dealt with a franchise before, and he has never assisted a client in the purchase or sale of a business, but he is eager to learn. Chris knows that his client is investing a significant amount of money in this venture, and that it is crucial that the transaction be conducted correctly, which makes him a little nervous.

What should Chris do?

22 Id. at 1.300.040.

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Independence Rules for CPAs

Learning objectives 1 I. The Threats and Safeguards Approach 1 II. Threats 2

A. Self-Review Threat 2 B. Advocacy Threat 2 C. Adverse Interest Threat 2 D. Familiarity Threat 2 E. Undue Influence Threat 3 F. Financial Self-Interest Threat 3 G. Management Participation Threat 3

III. Safeguards 4 IV. When is Independence Considered Impaired? 6

A. General Rules for Impairment 6 B. Employment or Association with Attest Clients 7 C. Considering Employment or Association With the Client 8 D. General Requirements for Performing Nonattest Services 8 E. General Activities That Impair Independence 9 F. Tax Compliance Services 9 G. Appraisal, Valuation, and Actuarial Services 10 H. Forensic Accounting Services 10 I. Q&A Regarding Independence 12

1. Advisory Board 12 2. Advisory Services 12 3. Alternative Dispute Resolution 13 4. Banking Relationships 13 5. Creditors’ Committee 13 6. Deferred Compensation Committee 14 7. Elected Office 14 8. Fee Disputes or Late Payments 14 9. Fiduciary Capacity 14 10. Firm Interrelationship 15 11. Indemnification Provisions 15 12. Leases 15 13. Limited Partnership Interest 15 14. Loans 16 15. Membership in Trade Association 16 16. Membership on Board of Directors of Client 16 17. Municipal Bond Ownership 17 18. Nonprofit Directors and Trustees 17 19. Political Campaigns 17 20. Real Estate Ownership 18 21. Significant Influence 18


Independence Rules for CPAs Learning objectives

Upon completion of this chapter, the reader should be able to: • Apply the risk-based approach to independence analysis; • Identify the primary threats to independents; • Identify the primary safeguards that can limit or eliminate threats to independence; • Describe the circumstances under which a CPA’s independence will be considered

impaired; and • Assess the independence impairment implications of non-attest services.

I. The Threats and Safeguards Approach Independence is the hallmark of a CPA engaged in an audit, review, or any attest engagement for a client. Determination of independence is made under a risk-based approach that assesses possible threats to independence and offsetting safeguards that can be used to reduce those threats to an acceptable level.1 Under this risk-based approach, a CPA’s relationship with a client is evaluated to determine whether it poses an unacceptable risk to the CPA’s independence. Because both actual independence impairment and apparent impairment equally undercut the public’s confidence, risk is deemed to be unacceptable if the relationship would compromise (or would be perceived as compromising by an informed third party having knowledge of all relevant information) the CPA's professional judgment when rendering an attest service. As such, threats to independence must be identified and assessed. If a significant threat exists, the CPA must determine whether it would be reasonable to expect that the threat would compromise his or her professional judgment and, if so, whether it can be effectively mitigated or eliminated. The risk-based approach involves the following steps:

(i) Identifying and evaluating threats to independence. The CPA must identify and evaluate not only individual threats, but the aggregate effect of threats as well. Threats can have a cumulative effect on independence. Where threats are identified, but due to the types of threats and their potential effects, such threats are considered to be at an acceptable level (that is, it is not reasonable to expect that the threats would compromise professional judgment), the consideration of safeguards is not required. If identified threats are not considered to be at an acceptable level, safeguards must be considered.

(ii) Determining whether safeguards already eliminate or sufficiently mitigate identified threats and whether threats that have not yet been mitigated can be eliminated or sufficiently mitigated by safeguards. Different safeguards can mitigate or eliminate different types of threats, and one safeguard can mitigate or eliminate several types of threats simultaneously. When threats are sufficiently mitigated by safeguards, the threats’ potential to compromise professional judgment is reduced to an acceptable level. A threat has been sufficiently mitigated by safeguards if, after application of the safeguards, it is not reasonable to expect that the threat would compromise professional judgment.

1 AICPA Code of Professional Conduct, 0.400.43.


(iii) If no safeguards are available to eliminate an unacceptable threat or reduce it to an acceptable level, independence would be considered impaired and the CPA should not proceed with the engagement.2

When independence is required, CPAs must be independent in both mind and appearance. Independence of mind is the state of mind that permits the performance of an attest service without being affected by influences that compromise professional judgment, thereby allowing an individual to act with integrity and exercise objectivity and professional skepticism. Independence in appearance means the avoidance of circumstances that would cause a reasonable and informed third party, having knowledge of all relevant information, including safeguards applied, to reasonably conclude that the integrity, objectivity, or professional skepticism of a firm or a member of the attest engagement team had been compromised.3

II. Threats There are seven basic threats to independence that should always be considered. These are by no means the only possible threats to independence, but provide a starting point for consideration in every audit engagement. Those seven basic threats that should be considered are discussed below.

A. Self-Review Threat CPAs who review, as part of an attest engagement, evidence that results from their own or their firms’ nonattest work (such as preparing source documents used to generate the client's financial statements) gives rise to the self-review threat.4 The public expects that CPAs are rendering opinions on the entity’s financial statements, not their own. When a CPA reviews evidence that the CPA created, it’s like a police investigator judging the credibility of his own testimony.

B. Advocacy Threat The advocacy threat exists when the CPA engages in actions promoting an attest client's interests or position. This may occur, for example, when the CPA is involved in promoting the client's securities as part of an initial public offering or representing a client in U.S. tax court.5 Neither of these situations automatically disqualifies the CPA as independent. However, whenever the CPA plays the role of advocate for the client in one engagement, it is a threat to the CPA’s independence in others.

C. Adverse Interest Threat The adverse interest threat refers to actions or interests between the CPA and the client that are in opposition. Examples would include commencing, or the expressed intention to commence, litigation by either the client or the CPA against the other.6

D. Familiarity Threat Familiarity with the client can be a great advantage to the CPA in many engagements, including audit engagements. However, when a CPA has a close or longstanding relationship with an attest client or knows individuals or entities (including by reputation) who performed nonattest services for the client, the CPA’s objectivity, and hence his or her independence is threatened.7 2 Id. at 0.400.01. 3 Id. at 0.400.21. 4 Id. at 0.400.01 et seq. 5 Id. 6 Id. 7 Id.


The familiarity threat may arise whenever a CPA, who is a member of the attest engagement team, has a spouse in a key position at the client’s office, such as the client's chief executive officer. There may also be a familiarity threat when a partner of the firm has provided the client with attest services for a prolonged period. For this reason, it may be a good idea to rotate audit partners periodically. There are other ways in which familiarity with the client could constitute a threat to independence. For example, a CPA of the firm having recently been a director or officer of the client, or a member of the attest engagement team who has a close friend who is in a key position at the client. The concern is that familiarity could result in the performance of insufficient audit procedures due to the familiarity.

E. Undue Influence Threat The undue influence threat may result from attempts by an attest client's management or other interested parties to coerce the member or exercise excessive influence over the member.8 This could take the form of a threat to replace the CPA or the CPA's firm over a disagreement with client management on the application of an accounting principle or pressure from the client to reduce necessary audit procedures for the purpose of reducing audit fees. Additionally, a gift from the client to the CPA that is other than clearly insignificant may be construed as an undue influence threat.

F. Financial Self-Interest Threat The financial self-interest threat is when there is potential benefit to a CPA from a financial interest in, or from some other financial relationship with, an attest client.9 This would include having a direct financial interest or material indirect financial interest in the client. It could also include having a loan from the client, from an officer or director of the client, or from an individual who owns 10 percent or more of the client's outstanding equity securities. Additionally, the financial self-interest threat may occur when there is excessive reliance on revenue from a single attest client or when the CPA or the CPA’s firm has a material joint venture or other material joint business arrangement with the client. In each of these cases the threat to independence should be seriously considered.

G. Management Participation Threat Taking on the role of client management or otherwise performing management functions on behalf of an attest client constitutes the management participation threat.10 The most common occurrences of this threat are when a CPA serves as an officer or director of the client or when the CPA or his or her firm establishes and maintains internal controls for the client. Serving in any capacity where the CPA is in a position to make management decisions for the client is problematic. Merely advising the client or making recommendations, however, should not constitute a threat to independence. Hiring personnel is generally a management decision and CPAs should refrain from participating in the actual decision making in this regard. This is not to say that a CPA cannot consult with the client regarding a candidate’s qualifications, or even participate in the interview process. It is the management decision making that must be avoided.

8 Id. 9 Id. 10 Id.


III. Safeguards Safeguards are controls that mitigate or eliminate threats to independence. Safeguards range from partial to complete prohibitions of the threatening circumstance to procedures that counteract the potential influence of a threat. The nature and extent of the safeguards to be applied depend on many factors, including the size of the firm and whether the client is a public interest entity. To be effective, safeguards should eliminate the threat or reduce the threat's potential to impair independence to an acceptable level.11 The effectiveness of a safeguard depends on many factors. Some of the factors that should be considered when assessing the effectiveness of a safeguard are:

The facts and circumstances specific to a particular situation; The proper identification of threats; Whether the safeguard is suitably designed to meet its objectives; The party or parties that will be subject to the safeguard; How the safeguard is applied; The consistency with which the safeguard is applied; and Who applies the safeguard.12

Safeguards can be divided into three broad categories. First, there are safeguards created by the profession, legislation, or regulation. For example, some of these safeguards would include:

Education and training requirements on independence and ethics rules for new professionals; Continuing education requirements on independence and ethics; Professional standards and monitoring and disciplinary processes; External review of a firm's quality control system; Legislation governing the independence requirements of the firm; and Competency and experience requirements for professional licensure.

Examples of safeguards implemented by the attest client that would operate in combination with other safeguards include:

The attest client has personnel with suitable skill, knowledge, and/or experience who make managerial decisions with respect to the delivery of nonattest services by the member to the attest client;

A tone at the top that emphasizes the attest client's commitment to fair financial reporting; Policies and procedures that are designed to achieve fair financial reporting; A governance structure, such as an active audit committee, that is designed to ensure

appropriate decision making, oversight, and communications regarding a firm's services; and Policies that dictate the types of services that the entity can hire the audit firm to provide without

causing the firm's independence to be considered impaired.

Perhaps the most important safeguards are those that are implemented by the CPA firm. Among the safeguards that any CPA firm participating in audit work should consider are the following:

Firm leadership that stresses the importance of independence and the expectation that members of attest engagement teams will act in the public interest;

Policies and procedures that are designed to implement and monitor quality control in attest engagements;

11 Id. 12 Id.


Documented independence policies regarding the identification of threats to independence, the evaluation of the significance of those threats, and the identification and application of safeguards that can eliminate the threats or reduce them to an acceptable level;

Internal policies and procedures that are designed to monitor compliance with the firm's independence policies and procedures;

Policies and procedures that are designed to identify interests or relationships between the firm or its partners and professional staff and attest clients;

The use of different partners and engagement teams that have separate reporting lines in the delivery of permitted nonattest services to an attest client, particularly when the separation between reporting lines is significant;

Training on and timely communication of a firm's policies and procedures, and any changes to them, for all partners and professional staff;

Policies and procedures that are designed to monitor the firm or partner's reliance on revenue from a single client and, if necessary, cause action to be taken to address excessive reliance;

Designating someone from senior management as the person who is responsible for overseeing the adequate functioning of the firm's quality control system;

A means of informing partners and professional staff of attest clients and related entities from which they must be independent;

A disciplinary mechanism that is designed to promote compliance with policies and procedures; Policies and procedures that are designed to empower staff to communicate to senior members

of the firm any engagement issues that concern them without fear of retribution; Policies and procedures relating to independence communications with audit committees or

others charged with client governance; Discussing independence issues with the audit committee or others responsible for the client's

governance; Disclosures to the audit committee (or others responsible for the client's governance) regarding

the nature of the services that are or will be provided and the extent of the fees charged or to be charged;

The involvement of another professional accountant who: (i) reviews the work that is done for an attest client; or (ii) otherwise advises the attest engagement team. (This individual could be someone from outside the firm or someone from within the firm who is not otherwise associated with the attest engagement);

Consultation on engagement issues with an interested third party, such as a committee of independent directors, a professional regulatory body, or another professional accountant;

Rotation of senior personnel who are part of the attest engagement team; Policies and procedures that are designed to ensure that members of the attest engagement

team do not make or assume responsibility for management decisions for the attest client; The involvement of another firm to perform part of the attest engagement; The involvement of another firm to re-perform a nonattest service to the extent necessary to

enable it to take responsibility for that service; The removal of an individual from an attest engagement team when that individual's financial

interests or relationships pose a threat to independence; A consultation function that is staffed with experts in accounting, auditing, independence, and

reporting matters who can help attest engagement teams: (i) assess issues when guidance is unclear, or when the issues are highly technical or require a great deal of judgment; and (ii) resist undue pressure from a client when the engagement team disagrees with the client about such issues;

Client acceptance and continuation policies that are designed to prevent association with clients that pose an unacceptable threat to the member's independence; and


Policies that preclude audit partners from being directly compensated for selling nonattest services to the audit client.

These examples are not intended to be all-inclusive and, conversely, the examples of safeguards implemented by the attest client and within the firm's own systems and procedures may not all be present in each instance. Within each category, the relative importance of a particular safeguard depends on its appropriateness in light of the facts and circumstances. In addition, threats may be sufficiently mitigated through the application of other safeguards not specifically identified above.13

IV. When is Independence Considered Impaired?

A. General Rules for Impairment Independence is considered to be impaired if the following occurs.

1. During the period of the professional engagement or during any period covered by the engagement, the CPA: a. Had or was committed to acquire any direct or material indirect financial interest

in the client. b. Was a trustee of any trust or executor or administrator of any estate if such trust

or estate had or was committed to acquire any direct or material indirect financial interest in the client and: (i) The covered member (individually or with others) had the authority to

make investment decisions for the trust or estate; or (ii) The trust or estate owned or was committed to acquire more than 10

percent of the client's outstanding equity securities or other ownership interests; or

(iii) The value of the trust's or estate's holdings in the client exceeded 10 percent of the total assets of the trust or estate.

c. Had a joint closely held investment that was material to the covered member. d. Had any loan to or from the client, any officer or director of the client, or any

individual owning 10 percent or more of the client's outstanding equity securities or other ownership interests.

2. During the period of the professional engagement, a partner or professional employee of the firm, his or her immediate family, or any group of such persons acting together owned more than five percent of a client's outstanding equity securities or other ownership interests.

3. During the period covered by the financial statements or during the period of the professional engagement, a firm, or partner or professional employee of the firm was simultaneously associated with the client as a(n): a. Director, officer, or employee, or in any capacity equivalent to that of a member

of management; b. Promoter, underwriter, or voting trustee; or c. Trustee for any pension or profit-sharing trust of the client.14

13 Id. 14 AICPA Code of Prof. Conduct, Interpretation 101-1.


B. Employment or Association with Attest Clients A firm’s independence will be considered to be impaired with respect to a client if a partner or professional employee leaves the firm and is subsequently employed by or associated with that client in a key position, unless ALL the following six conditions are met.

1. Amounts due to the former partner or professional employee for his or her previous interest in the firm and for unfunded, vested retirement benefits are not material to the firm, and the underlying formula used to calculate the payments remains fixed during the payout period. Retirement benefits may also be adjusted for inflation and interest may be paid on amounts due.

2. The former partner or professional employee is not in a position to influence the accounting firm's operations or financial policies.

3. The former partner or professional employee does not participate or appear to participate in, and is not associated with the firm, whether or not compensated for such participation or association, once employment or association with the client begins. An appearance of participation or association results from such actions as: a. The individual provides consultation to the firm; b. The firm provides the individual with an office and related amenities (e.g.,

secretarial and telephone services); c. The individual's name is included in the firm's office directory; and d. The individual's name is included as a member of the firm in other membership

lists of business, professional, or civic organizations, unless the individual is clearly designated as retired.

4. The ongoing attest engagement team considers the appropriateness or necessity of modifying the engagement procedures to adjust for the risk that, by virtue of the former partner or professional employee's prior knowledge of the audit plan, audit effectiveness could be reduced.

5. The firm assesses whether existing attest engagement team members have the appropriate experience and stature to effectively deal with the former partner or professional employee and his or her work, when that person will have significant interaction with the attest engagement team.

6. The subsequent attest engagement is reviewed to determine whether the engagement team members maintained the appropriate level of skepticism when evaluating the representations and work of the former partner or professional employee, when the person joins the client in a key position within one year of disassociating from the firm and has significant interaction with the attest engagement team.

As to the last requirement, the review should be performed by a professional with appropriate stature, expertise, and objectivity and should be tailored based on the position that the person assumed at the client, the position he or she held at the firm, the nature of the services he or she provided to the client, and other relevant facts and circumstances. Appropriate actions, as deemed necessary, should be taken based on the results of the review.15 Responsible members within the firm should implement procedures for compliance with the preceding conditions when firm professionals are employed or associated with attest clients.

15 Id. at 1.279.010.


With respect to conditions 4, 5, and 6 previously listed, the procedures adopted will depend on several factors, including whether the former partner or professional employee served as a member of the engagement team, the positions he or she held at the firm as well as with the client, the length of time that has elapsed since the professional left the firm, and the circumstances of his or her departure.

C. Considering Employment or Association With the Client When a member of the attest engagement team or an individual in a position to influence the attest engagement intends to seek or discuss potential employment or association with an attest client, or is in receipt of a specific offer of employment from an attest client, independence will be impaired with respect to the client unless the person promptly reports such consideration or offer to an appropriate person in the firm, and removes himself or herself from the engagement until the employment offer is rejected or employment is no longer being sought. When a CPA becomes aware that a member of the attest engagement team or an individual in a position to influence the attest engagement is considering employment or association with a client, the covered member should notify an appropriate person in the firm.16 The appropriate person should consider what additional procedures may be necessary to provide reasonable assurance that any work performed for the client by that person was performed with objectivity and integrity. Additional procedures, such as re-performance of work already done, will depend on the nature of the engagement and the individual involved.17

D. General Requirements for Performing Nonattest Services There are four general requirements with respect to the performance of nonattest services for an audit client. They are described as follows.

1. A CPA should not perform management functions or make management decisions for the attest client. However, the member may provide advice, research materials, and recommendations to assist the client's management in performing its functions and making decisions.

2. The client must agree to perform the following functions in connection with the engagement to perform nonattest services: a. Make all management decisions and perform all management functions; b. Designate an individual who possesses suitable skill, knowledge, and/or

experience, preferably within senior management, to oversee the services; c. Evaluate the adequacy and results of the services performed; and d. Accept responsibility for the results of the services

3. The member should be satisfied that the client will be able to meet all of these criteria and make an informed judgment on the results of the member’s nonattest services. In assessing whether the designated individual possesses suitable skill, knowledge, and/or experience, the member should be satisfied that such individual understands the services to be performed sufficiently to oversee them. However, the individual is not required to possess the expertise to perform or re-perform the services.

4. In cases where the client is unable or unwilling to assume these responsibilities (for example, the client does not have an individual with suitable skill, knowledge, and/or experience to oversee the nonattest services provided, or is unwilling to perform such

16 Id. 17 Id.


functions due to lack of time or desire), the member’s provision of these services would impair independence.18

Before performing nonattest services, a CPA should establish and document in writing his or her understanding with the client (board of directors, audit committee, or management, as appropriate in the circumstances) regarding the following:

Objectives of the engagement; Services to be performed; Client's acceptance of its responsibilities; Member's responsibilities; and Any limitations of the engagement.

E. General Activities That Impair Independence The following are some general activities that would impair a member's independence:

Authorizing, executing or consummating a transaction, or otherwise exercising authority on behalf of a client or having the authority to do so;

Preparing source documents, in electronic or other form, evidencing the occurrence of a transaction;

Having custody of client assets; Supervising client employees in the performance of their normal recurring activities; Determining which recommendations of the member should be implemented; Reporting to the board of directors on behalf of management; Serving as a client's stock transfer or escrow agent, registrar, general counsel or its equivalent;

and Establishing or maintaining internal controls, including performing ongoing monitoring activities for

a client.19

F. Tax Compliance Services The types of tax compliance services addressed by this interpretation are preparation of a tax return, transmittal of a tax return and transmittal of any related tax payment to the taxing authority, signing and filing a tax return, and authorized representation of clients in administrative proceedings before a taxing authority.20 Preparing a tax return and transmitting the tax return and related tax payment to a taxing authority, in paper or electronic form, would not impair a member's independence provided the member does not have custody or control over the client’s funds. Furthermore, the individual designated by the client to oversee the tax services must review and approve the tax return and related tax payment; and, if required for filing, signs the tax return prior to the member transmitting the return to the taxing authority.21 Notwithstanding the foregoing, signing and filing a tax return on behalf of client management would impair independence, unless the member has the legal authority to do so, and:

1. The taxing authority has prescribed procedures in place for a client to permit a member to sign and file a tax return on behalf of the client (e.g., Form 8879 or 8453), and such procedures meet, at the minimum, standards for electronic return originators and officers outlined in IRS Form 8879; or

18 Id. at 1.295.010. 19 Id. 20 Id. 21 Id.


2. An individual in client management who is authorized to sign and file the client's tax return provides the member with a signed statement that clearly identifies the return being filed and represents that: a. Such individual is authorized to sign and file the tax return; b. Such individual has reviewed the tax return, including accompanying schedules

and statements, and it is true, correct and complete to the best of his or her knowledge and belief; and

c. Such individual authorizes the member or another named individual in the member's firm to sign and file the tax return on behalf of the client.

Authorized representation of a client in administrative proceedings before a taxing authority would not impair a member's independence provided the member obtains client agreement prior to committing the client to a specific resolution with the taxing authority. However, representing a client in a court to resolve a tax dispute would impair a member's independence.22

G. Appraisal, Valuation, and Actuarial Services Independence would be impaired if a CPA performs an appraisal, valuation, or actuarial service for an attest client where the results of the service, individually or in the aggregate, would be material to the financial statements and the appraisal, valuation, or actuarial service involves a significant degree of subjectivity.23 Valuations performed in connection with, for example, employee stock ownership plans, business combinations, or appraisals of assets or liabilities generally involve a significant degree of subjectivity. Accordingly, if these services produce results that are material to the financial statements, independence would be impaired.24 An actuarial valuation of a client's pension or postemployment benefit liabilities generally produces reasonably consistent results because the valuation does not require a significant degree of subjectivity. Therefore, such services would not impair independence. In addition, appraisal, valuation, and actuarial services performed for nonfinancial statement purposes would not impair independence. However, in performing such services, all other requirements of this interpretation should be met, including that all significant assumptions and matters of judgment are determined or approved by the client and the client is in a position to have an informed judgment on, and accepts responsibility for, the results of the service.25

H. Forensic Accounting Services Forensic accounting services consist of nonattest services that involve the application of special skills in accounting, auditing, finance, quantitative methods and certain areas of the law, and research, and investigative skills to collect, analyze, and evaluate evidential matter and to interpret and communicate findings and generally consist of litigation services and investigative services.26 The work of accountants intersects with civil litigation in a variety of contexts. Accountants often play an integral part in litigation as expert witnesses or consultants to the court or the litigants. For example,

22 Id. Note that a CPA representing a client before the IRS must also comply with IRS Circular 230, discussed below. 23 AICPA Code of Prof. Conduct, 1.295.010. 24 Id. 25 Id. 26 Id.


cases involving accounting determinations subject to manipulation, such as earn-out agreements27 related to the sale of a business, will require expert testimony from accountants. Accountants may be consulted with regard to bankruptcy matters and may assist in interpreting financial documents in cases where undue influence issues are raised. Furthermore, expert testimony from accountants has been used extensively in divorce cases. Accounting experts may be called upon to assist in the process of segregating property that originated from different sources but that has been mingled with in such a manner that it has lost its identity. This process is especially important in the context of secured transactions when collateral is sold by a debtor and the proceeds mingled with other funds of the debtor. Expert accounting testimony is also used in many other types of disputes. In one case accounting testimony was used to establish the amount of Taster’s Choice coffee that was sold due to a particular model’s likeness appearing on the label.28 Expert accounting testimony has been used to establish the correct characterization of accounting information,29 accurate balance due on promissory notes,30 the yield obtainable from raw products in a lumber operation,31 the amount of profits obtained by virtue of a breach of loyalty,32 and weaknesses in internal controls in an embezzlement case.33 Litigation services recognize the role of the CPA as an expert or consultant and consist of providing assistance for actual or potential legal or regulatory proceedings before a court or arbitration panel in connection with the resolution of disputes between parties. Expert witness services are those litigation services where a member is engaged to render an opinion as to the matter(s) in dispute based on the CPA's expertise, rather than his or her direct knowledge of the disputed facts or events. Although expert witnesses are ostensibly called to give unbiased opinion testimony, by their nature expert witness services create the appearance that the CPA is advocating or promoting a client's position. Remember that the CPA must be independent in both mind and appearance to perform audit services. Accordingly, if a CPA conditionally or unconditionally agrees to provide expert witness testimony for a client, independence would be considered to be impaired. However, it should be noted that independence would not be considered impaired if a CPA provides expert witness services for a large group of plaintiffs or defendants that includes one or more attest clients of the firm provided that at the outset of the engagement: (a) the CPA’s attest clients constitute less than 20 percent of (i) the members of the group, (ii) the voting interests of the group, and (iii) the claim; (b) no attest client within the group is designated as the "lead" plaintiff or defendant of the group; and (c) no attest client has the sole decision-making power to select or approve the expert witness.34 Since experts are providing opinions, they are not considered to be “fact witnesses.” Of course, a CPA may also be called upon to testify as a fact witness. While testifying as a fact witness, a CPA may be 27 An “earn out” agreement is a provision related to the sale of a business in which the buyer agrees to pay to the seller an

additional amounts as part of the purchase price if certain sales or profit thresholds are obtained. 28 Christoff v. Nestle USA, Inc., 62 Cal.Rptr.3d 122 (2007). 29 Consolidated Insured Benefits, Inc. v. Conseco Medical Ins. Co., Slip Copy, 2006 WL 3423891 (D.S.C.); see e.g.,

Brassco, Inc. v. Klipo, 2006 WL 223154 (S.D.N.Y.); In re Seaway Intern. Transport, Inc., 341 B.R. 333 (2006). 30 Romi's Exp. v. Gil, 2007 WL 901724 (Cal.App. 2 Dist.). 31 In re Stoney Creek Technologies, LLC, 364 B.R. 882 (2007). 32 Lyle Carlstrom Associates, Inc. v. Lyle, 2007 WL 114203 (N.J.Super.A.D.). 33 People v. Lupo, 2006 WL 3788781 (Cal.App. 2 Dist.). For other embezzlement cases involving expert accounting

testimony see Paschal v. Great Western Drilling, Ltd., 215 S.W.3d 437 (2006); In re Bozeman, Slip Copy, 2006 WL 2860788 (Bkrtcy.M.D.La.).

34 AICPA Code of Prof. Conduct, 1.295.010.


questioned by the court or counsel as to his or her opinions pertaining to matters within the CPA's area of expertise. Answering such questions would not impair the member's independence.35 In addition to actual testimony, litigation consulting services are those litigation services where a CPA provides advice about the facts, issues, and strategy of a matter. The performance of litigation consulting services would not impair independence provided the CPA complies with the general requirements for independence. However, if the CPA subsequently agrees to serve as an expert witness, independence would be considered to be impaired.36 Other services may include those litigation services where a CPA serves as a trier of fact, special master, court-appointed expert, or arbitrator (including serving on an arbitration panel), in a matter involving a client. These other services create the appearance that the CPA is not independent, and therefore, if a CPA serves in such a role, independence would be considered to be impaired. However, independence would not be considered impaired if the CPA serves as a mediator or any similar role in a matter involving a client provided the CPA is not making any decisions on behalf of the parties, but rather is acting as a facilitator by assisting the parties in reaching their own agreement.37

I. Q&A Regarding Independence Reproduced below are selected questions and answers regarding the independence requirement. This information appears as the AICPA Code of Professional Conduct Ethics Rulings on Independence in ET §191.

1. Advisory Board Question—Would service on a client's advisory board impair independence? Answer—Independence would be considered to be impaired if any partner or professional employee of the firm served on the advisory board unless all the following criteria are met: (i) the responsibilities of the advisory board are in fact advisory in nature; (ii) the advisory board has no authority to make nor does it appear to make management decisions on behalf of the client; and (iii) the advisory board and those having authority to make management decisions (including the board of directors or its equivalent) are distinct groups with minimal, if any, common membership.

2. Advisory Services Question—A CPA provides extensive advisory services for a client. In that connection, the CPA attends board meetings, interprets financial statements, forecasts and other analyses, counsels on potential expansion plans and on banking relationships. Would independence be considered to be impaired under these circumstances? Answer—Independence would not be considered to be impaired because the member's role is advisory in nature.

35 Id. 36 Id. 37 Id.


3. Alternative Dispute Resolution Question—Alternative dispute resolution (ADR) techniques are used to resolve disputes (in lieu of litigation) relating to past services, but are not used as a substitute for the exercise of professional judgment for current services. Would a predispute agreement to use ADR techniques between a CPA or his or her firm and a client cause independence to be impaired? Answer—No. Such an agreement would not cause independence to be impaired since the CPA (or the firm) and the client would not be in threatened or actual positions of material adverse interests by reason of threatened or actual litigation. Question—Would the commencement of an alternative dispute resolution (ADR) proceeding impair independence? Answer—Except as stated in the next sentence, independence would not be considered to be impaired because many of the ADR techniques designed to facilitate negotiation and the actual conduct of those negotiations do not place the CPA or his or her firm and the client in threatened or actual positions of material adverse interests. Nevertheless, if a CPA and the client are in a position of material adverse interests because the ADR proceedings are sufficiently similar to litigation, ethics interpretation 101-6 [ET §101.08] should be applied. Such a position would exist if binding arbitration were used.

4. Banking Relationships Question—A CPA maintains checking or savings accounts, certificates of deposit, or money market accounts at a client financial institution. Would these depository relationships impair independence? Answer—Independence would not be considered to be impaired provided that: (i) the checking accounts, savings accounts, certificates of deposit, or money market accounts were fully insured by the appropriate state or federal government deposit insurance agencies or by any other insurer; or (ii) the uninsured amounts, in the aggregate, were not material to the net worth of the covered member. (When insured amounts were considered material, independence would not be considered impaired provided the uninsured balance was reduced to an immaterial amount no later than 30 days from the date the uninsured amount becomes material.) A firm's depository relationship would not impair its independence provided that the likelihood of the financial institution experiencing financial difficulties was considered to be remote.

5. Creditors’ Committee Question—A CPA performs the following functions for a creditors' committee in control of a debtor corporation that will continue to operate under its existing management subject to extension agreements: (i) signs or co-signs checks issued by the debtor corporation; (ii) signs or co-signs purchase orders in excess of established minimum amounts; and (iii) exercises general supervision to insure compliance with budgetary controls and pricing formulas established by management, with the consent of the creditors, as part of an overall program aimed at the liquidation of deferred indebtedness. Would independence be considered to be impaired with respect to the debtor corporation? Answer—Independence would be considered to be impaired if any partner or professional employee of the firm performed any of the functions described, since these are considered to be management functions.


6. Deferred Compensation Committee Question—Would independence be considered to be impaired if a CPA served on a committee that administers a client's deferred compensation program? Answer—Independence would be considered to be impaired if any partner or professional employee of the firm served on the committee since such service constitutes participation in the client's management functions. The partner or professional employee could however render consulting assistance without joining the committee.

7. Elected Office Question—A CPA is an elected legislator in a local government (a city). The city manager, who is responsible for all administrative functions, is also an elected official. Would independence be considered to be impaired with respect to the city? Answer—Independence would be considered to be impaired if any partner or professional employee of the firm served as an elected legislator for a city at the same time his or her firm was engaged to perform the city's attest engagement, even though the city manager is an elected official rather than an appointee of the legislature.

8. Fee Disputes or Late Payments Question—A client of the member's firm has not paid fees for previously rendered professional services. Would independence be considered to be impaired for the current year? Answer—Independence is considered to be impaired if, when the report on the client's current year is issued, billed or unbilled fees, or a note receivable arising from such fees, remain unpaid for any professional services provided more than one year prior to the date of the report.

9. Fiduciary Capacity Question—A CPA has been designated to serve as an executor or trustee of the estate of an individual who owns the majority of a client's stock. Would independence be considered to be impaired with respect to the client? Answer—The mere designation of a covered CPA as executor or trustee would not be considered to impair independence, however, if a covered CPA actually served in such capacity, independence would be considered to be impaired. Question—A CPA serves with a client bank in a co-fiduciary capacity with respect to an estate or trust. Would independence be considered to be impaired with respect to the bank or the bank's trust department? Answer—Independence would not be considered to be impaired provided the assets in the estate or trust were not material to the total assets of the bank and/or the bank's trust department. Question—A charitable foundation is the sole beneficiary of the estate of the foundation's deceased organizer. If a CPA becomes a trustee of the foundation, would independence be considered to be impaired with respect to: (i) the foundation; or (ii) the estate?


Answer—If a covered CPA served as trustee of the foundation, independence would be considered to be impaired with respect to both the foundation and the estate.

10. Firm Interrelationship Question—Firm A is not independent with respect to a client. Partners or professional employees of Firm A are participating on Firm B's attest engagement team for that client. Would Firm B's independence be considered to be impaired? Answer—Yes. The use by Firm B of partners or professional employees from Firm A as part of the attest engagement team would impair Firm B's independence with respect to that engagement. However, use of the work of such individuals in a manner similar to internal auditors is permissible provided that there is compliance with the Statements on Auditing Standards. Applicable literature contained in the Statements on Auditing Standards should be consulted.

11. Indemnification Provisions Question—A CPA or his or her firm proposes to include in engagement letters a clause that provides that the client would release, indemnify, defend, and hold the CPA (and his or her partners, heirs, executors, personal representatives, successors, and assigns) harmless from any liability and costs resulting from knowing misrepresentations by management. Would inclusion of such an indemnification clause in engagement letters impair independence? Answer—No. Question—As a condition to retaining a CPA or his or her firm to perform an attest engagement, a client or prospective client requests that the CPA (or the firm) enter into an agreement providing, among other things, that the CPA (or the firm) indemnify the client for damages, losses, or costs arising from lawsuits, claims, or settlements that relate, directly or indirectly, to client acts. Would entering into such an agreement impair independence? Answer—Yes. Such an agreement would impair independence.

12. Leases Question—Would independence be considered to be impaired if a CPA leased property to or from a client? Answer—Independence would not be considered to be impaired if the lease meets the criteria of an operating lease (as described in Generally Accepted Accounting Principles), the terms and conditions set forth in the lease agreement are comparable with other leases of a similar nature, and all amounts are paid in accordance with the terms of the lease.

13. Limited Partnership Interest

Question—A private, closely held entity is the general partner and controls (as defined in Generally Accepted Accounting Principles) limited partnership A. The CPA has a material financial interest in limited partnership A. The member's firm has been asked to perform an attest engagement for a new limited partnership (B), which has the same general partner as limited partnership A. Would independence be considered to be impaired with respect to limited partnership B?


Answer—Because the general partner has control over limited partnership A, the covered CPA would be considered to have a joint closely held investment with the general partner, who has significant influence over limited partnership B, the proposed client. Accordingly, independence would be considered to be impaired with respect to limited partnership B if the covered CPA had a material investment in limited partnership A. Question—A CPA is a limited partner in a limited partnership (LP), including a master limited partnership. A client is a general partner in the same LP. Is independence considered to be impaired with respect to: (1) the LP; (2) the client; and (3) any subsidiaries of the LP? Answer— (1) A member's limited partnership interest in the LP is a direct financial interest in the LP that would impair independence. (2) The LP is an investee of the client because the client is a general partner in the LP. Therefore, if the investment in the LP were material to the client, a member's financial interest in the LP would impair independence. However, if the client's financial interest in the LP were not material to the client, a covered member's immaterial financial interest in the LP would not impair independence. (3) If the CPA is a limited partner in the LP, the CPA is considered to have an indirect financial interest in all subsidiaries of the LP. If the indirect financial interest in the subsidiaries were material to the member, independence would be considered to be impaired with respect to those subsidiaries. If the CPA or client general partner, individually or together can control the LP, the LP would be considered a joint closely held investment.

14. Loans Question—Would the mere servicing of a loan by a client financial institution impair independence with respect to the client? Answer—No. Question—A CPA has obtained a loan from a nonclient. The member's firm performs an attest engagement for the parent or a subsidiary of the nonclient. Does the loan from the nonclient subsidiary or parent impair independence? Answer—A member's loan from a nonclient subsidiary would impair independence with respect to the client parent. However, a loan from a nonclient parent would not impair independence with respect to the client subsidiary as long as the subsidiary is not material to its parent.

15. Membership in Trade Association Question—Would independence be considered to be impaired if a CPA joined a trade association that is a client of the firm? Answer—Independence would not be considered to be impaired provided the CPA did not serve as an officer, director, or in any capacity equivalent to that of a CPA of management.

16. Membership on Board of Directors of Client Question—A CPA serves in the dual capacity of director of an entity and auditor of the financial statements of that entity's profit sharing and retirement trust (the trust). Would independence be considered to be impaired with respect to the trust?


Answer—Service as director of an entity constitutes participation in management functions that affect the entity's trust. Accordingly, independence would be considered to be impaired if any partner or professional of the firm served in such capacity.

17. Municipal Bond Ownership Question—Would independence be considered to be impaired if a CPA owned an immaterial amount of a municipal authority's outstanding bonds? Answer—Ownership of a client's bonds constitutes a loan to that client. Accordingly, if a covered CPA owned such bonds, independence would be considered to be impaired.

18. Nonprofit Directors and Trustees Question—A CPA serves as a director or officer of a United Way or similar federated fund-raising organization (the organization). Certain local charities receive funds from the organization. Would independence be considered to be impaired with respect to such charities? Answer—Independence would be considered to be impaired if any partner or professional employee of the firm served as a director or officer of the organization and the organization exercised managerial control over the local charities. Question—Would independence be considered to be impaired if a CPA served on the board of directors of a nonprofit social club? Answer—Independence would be considered to be impaired if any partner or professional employee of the firm served on the board of directors since the board has ultimate responsibility for the club's affairs. Question—A CPA serves on the board of directors of an organization. A fund-raising foundation functions solely to raise funds for that organization. Would independence be considered to be impaired with respect to the fund-raising foundation? Answer—Independence would be considered to be impaired with respect to the fund-raising foundation if any partner or professional employee of the firm served on the organization's board of directors. However, if the directorship were clearly honorary, independence would not be considered to be impaired.

19. Political Campaigns Question—A CPA serves as the campaign treasurer of a mayoral candidate. Would independence be considered to be impaired with respect to: (i) the political party with which the candidate is associated; (ii) the municipality of which the candidate may become mayor; or (iii) the campaign organization? Answer—Independence would not be considered to be impaired with respect to the political party or municipality. However, if any partner or professional employee of the firm served as campaign treasurer, independence would be considered to be impaired with respect to the campaign organization.


20. Real Estate Ownership Question—A CPA has a joint interest in a vacation home with a client (or one of the client's officers or directors, or any owner who has the ability to exercise significant influence over the client). Would the vacation home constitute a "joint closely held investment"? Answer—Yes. The vacation home, even if solely intended for the personal use of the owners, would be considered a joint closely held investment.

21. Significant Influence Question—Would independence be considered to be impaired if a CPA or his or her firm had significant influence over an entity that has significant influence over a client? Answer—Independence would be considered to be impaired if any partner or professional of the firm had significant influence over an entity that has significant influence over a client. By having such influence over the non-client entity, the partner or professional employee would also be considered to have significant influence over the client.


Ethics and Tax Practice

Learning objectives 1 I. Authority to Promulgate Ethics Rules 1 II. What Constitutes “Practice Before the IRS”? 1 III. Persons Authorized to Practice Before the IRS 4

A. Certified Public Accountants 4 B. Enrolled Agents 5 C. Enrolled Actuaries 5 D. Enrolled Retirement Plan Agents 6 E. Appraisers 7 F. Annual Filing Season Program Participants 8

IV. Continuing Professional Education 8 V. PTINS 9 VI. Sanctions 10

A. Types of Sanctions 10 B. Increased Sanctions Upon Appeal 11 C. The Process for Imposing Sanctions 12

VII. Conduct Giving Rise to Sanctions 14 A. Standards 14 B. Incompetence and Disreputable Conduct 14 C. Criminal Convictions 15 D. Tax Protestors and Tax Shelter Promoters 16 E. Laziness Leading to Sanctions for Incompetence and Disreputable Conduct 17 F. Use of Cancelation of Debt Reporting as a Form of Collection 18

VIII. What Kinds of Cases Result in Disbarment? 20 A. Distinction Between Disbarment and Suspension 20 B. Disbarment for Failure to File 20 C. Disbarment Involving Incompetence 22 D. Disbarment Based on Criminal Convictions 23

IX. What Kinds of Cases Result in Suspensions? 24 A. Suspension for Failure to File 24 B. Suspension for Misrepresentation 25 C. Sanctions Imposed for Anger Management Issues 26

X. Conduct That Does Not Violate Circular 230 27 A. Valid Excuses for Nonpayment 27 B. Disclosure in Collection Cases 28 C. Being Wrong in a Written Opinion 29

XI. New Written Advice Standards 29


Ethics and Tax Practice Learning objectives

Upon completion of this chapter, the reader should be able to: • Understand the scope of activities to which Circular 230 applies; • Properly utilize Personal Tax Identification Numbers (“PTINs”); • Identify the types of sanctions that may be imposed under Circular 230; • Understand the disciplinary process that applies if a Circular 230 violation is alleged; and • Identify the specific types of conduct that may lead to sanctions under Circular 230.

I. Authority to Promulgate Ethics Rules Federal law delegates to the Secretary of the Treasury the power to proscribe rules and regulations governing the representation of taxpayers (i.e., “practice”) before the Internal Revenue Service (“IRS”).1 The Treasury regulations that have been promulgated pursuant to this authority are contained in the Code of Federal Regulations at 31 C.F.R. part 10. These regulations are also published in a pamphlet referred to as “Treasury Department Circular No. 230,” more commonly referred to as simply “Circular 230.” The IRS Office of Professional Responsibility (“OPR”) administers and enforces Circular 230. Originally referred to as the “Office of the Director of Practice,” in 1982 OPR adopted its current name and moved from the Treasury Department to the IRS. OPR is currently responsible for determining which individuals are eligible to practice before the IRS and pursues disciplinary action against those who transgress the rules of Circular 230.

II. What Constitutes “Practice Before the IRS”? The concept of “practice before the IRS” as described in Circular 230 is extremely broad, and purports to include all matters connected with representation of a taxpayer with regard to the taxpayer’s rights, privileges, or liabilities under any law or regulation administered by the IRS. Specifically, preparing and filing documents (including tax returns and claims for refund), corresponding and communicating with the IRS, and representing a taxpayer at conferences, hearings, or meetings with the IRS constitute practice before the IRS under Circular 230.2 While it should be fairly obvious that any direct contact through correspondence, other communications, or representing a taxpayer at a conference or hearing would constitute practice before the IRS, the definition encompasses many activities that do not involve such obvious interaction with the IRS. Specifically, the extent to which preparing and filing tax returns or providing written advice to taxpayers constitutes “practice before the IRS” has not been altogether clear. For example, the pre-2010 amendments version of Circular 230 specifies that “preparing and filing documents” constitutes practice before the IRS. Do “documents” include tax returns?

1 31 U.S.C. § 330. 2 31 CFR 10.2(a)(4).


Arguably, no. Previously, Circular 230 specifically provided that “neither the preparation of tax returns nor the furnishing of information at the request of the [IRS] is considered practice before the Service.”3 Although this language has been removed as a modifier to the definition of practice, Circular 230 still separately provides that “any individual may prepare a tax return . . . or furnish information at the request of the IRS.”4 Nonetheless, the IRS apparently took the position that the preparation and filing of tax returns does constitute practice before the IRS and is governed by Circular 230. In issuing proposed amendments to Circular 230 in 2010 Treasury stated that, “Under the current definition of practice, preparing a tax return or claim for refund . . . is practice before the IRS. Similarly, an individual who files a tax return or claim for refund prepared by someone else also is engaged in practice before the IRS.”5 This language, included in the background discussion of the proposed amendments, ostensibly addresses a more subtle issue. Due to the conjunctive connector between “preparing” and “filing” contained in the pre-2010 amendments version of Circular 230, it is reported that some commentators have suggested that it is only when a practitioner both prepares and files a return or claim for refund that the practitioner is practicing before the IRS. The language included with the proposed amendments is designed to disabuse readers of that notion. Consistent with this IRS position, the amended version of Circular 230 eliminates the conjunctive “and” between “preparing” and “filing.” Seemingly contradicting the position that simply preparing a return constitutes practice before the IRS, OPR has ruled that practitioners sanctioned under the pre-amended version of Circular 230 will not be automatically prohibited from practice as tax return preparers by virtue of that sanction. Specifically, OPR states that, “In other words, practitioners who have been suspended or disbarred under existing Circular 230 will not be denied the opportunity to . . . prepare tax returns because they are prohibited from ‘practice’ as it has been defined historically.” OPR goes on to state that this position took into account the fact that, “a number of attorneys, certified public accountants and enrolled agents have agreed to Circular 230 sanctions in reliance on the fact that any sanction imposed under Circular 230 would not foreclose them from earning a livelihood as a tax return preparer.”6 Thus, almost concurrently with the Treasury/IRS proclamation that the “current” definition of practice includes preparing tax returns, OPR has issued an announcement acknowledging that preparing returns has not been considered practice “as it has been defined” prior to the 2010 proposed amendments. However, with the federal court decision in Ridgely v. Lew; 1:12-cv-00565 (D.D.C. 2014), the OPR’s ability to police return filing practice has come under serious question. The Ridgely court ruled that a CPA who prepares an original or amended return is not engaged in representation of taxpayers and thus is not engaged in practice subject to Circular 230. Thus, in the court’s opinion, Circular 230 regulates CPAs, attorneys, and enrolled agents only when they are involved in examination or appeals representation. As a result, many of the conduct provisions in Circular 230 would seemingly not apply when a CPA is engaged in return preparation, and only the statutory constraints would apply to preparation activity. The Ridgely court cited the statutory regime surrounding return preparation as a factor in concluding that return preparation was not practice under Circular 230. Perhaps even more significant, arguably the rules 3 23 Fed. Reg. 9,261, 9,262 (Nov. 29, 1958). 4 31 CFR 10.7(e). 5 REG-138637-07. 6 OPR announcement found at http://www.irs.gov/taxpros/article/0,,id=235496,00.html.


concerning written advice in section 10.37 of Circular 230 may be inapplicable if the advice is non-tax-shelter written advice concerning tax return reporting provisions. In fact, the potential impact of this case goes even further. For example, the Circular 230 due diligence and supervisory provisions regarding return preparation by CPAs, enrolled agents, and attorneys may not apply if the preparation of returns, amended returns, and claims for refund is not practice before the IRS. At least one commentator has observed that the competency requirement in section 10.35 would arguably not apply to return preparation activity because it is not representation and therefore not practice before the IRS.7 Presumably this change does not directly affect enrolled agents, since their status as such is a creature of Circular 230. Furthermore, note that most CPAs must still comply with the Code of Professional Ethics of the American Institute of Certified Public Accountants and that organization’s Statements on Standards for Tax Services. Since those standards are similar to those contained in Circular 230, the substance of the applicable conduct rules has really not changed for most practitioners, rather, it is the OPR’s ability to enforce the rules that has been eviscerated. “Rendering written advice with respect to any entity, transaction, plan, or arrangement” is also identified as constituting practice before the IRS in Circular 230.8 Prior to the 2007 amendments to Circular 230, it was not clear that the isolated act of rendering written advice was within the ambit of “practice before the IRS.” In the preamble to those regulations, however, it was made clear that, “The Treasury Department and IRS conclude that the rendering of written advice is practice before the IRS subject to Circular 230 when it is provided by a practitioner.” Hence, a practitioner may be disciplined by OPR for inappropriately rendering written advice to a taxpayer even when the practitioner has had no direct (or indirect) contact with the IRS. It seems counter-intuitive that the reach of a sanction under Circular 230 would extend to the providing of advice to a taxpayer outside of any proceeding before the IRS. It is, however, clear that the IRS maintains that, when a practitioner renders written advice, they are practicing before the IRS. This is somewhat peculiar in that it is not really the action (i.e., giving written advice) that triggers inclusion in the definition, but rather the source of the action (i.e., a practitioner). Unfortunately, neither the IRS nor OPR has provided definitive guidance in this regard. The more one dissects this position, the more strange it seems. “Practitioner” is defined by reference to section 10.3 of Circular 230, which, with respect to each category, identifies a practitioner as one who “is not under suspension or disbarment.” Thus, Circular 230 regulates the written advice of an attorney or CPA who is not under suspension or disbarment. However, a practitioner who has been suspended or disbarred is, arguably, free to render written advice without considering the constraints of Circular 230 because the suspended or disbarred practitioner is, by definition, not “practicing before the IRS.” Furthermore, it appears that the IRS makes a distinction between written advice generally and providing tax advice connected to a return or other document to be submitted to the IRS. For example, a registered tax return preparer is not authorized under the amended version of Circular 230 to provide tax advice “except as necessary to prepare a tax return, claim for refund, or other document intended to be submitted to the IRS.” Given this distinction, one could draw the logical conclusion that providing advice connected to a return or other document to be submitted to the IRS constitutes an activity not encompassed within the phrase “rendering written advice” as used in Circular 230.

7 Dellinger, Kip, Stop the “Inversion”: Save Circular 230, 145 Tax Notes 1163 (Dec. 8, 2014). 8 31 CFR 10.2(a)(4).


The resolution of this issue may be of particular importance to determining what a tax professional can and cannot do after a suspension or disbarment. If the professional is employed by a firm, for example, Circular 230 provides that suspension or disbarment restricts the firm from accepting assistance from that individual, or allowing him or her to assist in matters constituting “practice” before the IRS.9 Does this mean that the individual must refrain from advising clients on federal tax matters? The courts have begun to weigh on this issue in a significant way. A D.C. Circuit Court case called Loving v. IRS10 held that the authority of the IRS does not extend to individuals who are not “representatives of persons before the [IRS].” In Loving the D.C. Circuit stated that “Section 330 of Title 31 authorizes the Secretary of the Treasury—and by extension, the IRS, a subordinate agency within the Treasury Department—to ‘regulate the practice of representatives of persons before the Department of the Treasury.’ The Circuit Court addressed the question of “whether the IRS's authority to ‘regulate the practice of representatives of persons before the Department of the Treasury’ encompasses authority to regulate tax-return preparers. The Circuit Court answered in the negative. In so doing, the D.C. Circuit found that tax preparers are not representatives under Section 330: “[i]n light of the way the Code treats tax preparation, it would be quite wrong to say that a tax-return preparer ‘represents’ the taxpayer in any meaningful legal sense. In short, the statute's use of the term ‘representative’ excludes tax-return preparers.” The D.C. Circuit further found that preparing and signing tax returns are not considered as practice before the Department: “[a]lthough the exact scope of ‘practice before’ a court or agency varies depending on the context, to ‘practice before’ a court or agency ordinarily refers to practice during an investigation, adversarial hearing, or other adjudicative proceeding.” The U.S. District Court for Nevada agreed with the analysis and holding of the D.C. Circuit in Loving in its opinion in Sexton v. Hawkins.11 In that case the court rejected the IRS argument that their authority and jurisdiction extends to tax professionals who are not authorized to practice before the IRS because they are suspended from practice due to misconduct.

III. Persons Authorized to Practice Before the IRS Individuals who are generally eligible to represent taxpayers before the IRS are referred to as “practitioners.” Practitioners include attorneys, certified public accountants, enrolled agents, enrolled actuaries, and enrolled retirement plan agents. In addition, appraisers meeting certain qualifications may provide supporting valuations with respect to matters before the IRS.

A. Certified Public Accountants A certified public accountant (“CPA”) is defined as any person who is duly qualified to practice as a CPA in any state, territory, or possession of the United States, including the District of Columbia.12 Note that the phrase “qualified to practice as a certified public accountant” indicates that the authority to practice before the IRS is not limited to persons who are licensed CPAs, but in fact includes individuals that a state has authorized to perform the same services as licensed CPAs.13

9 31 CFR 10.24. 10 742 F.3d 1013 (D.C. Cir. 2014). 11 742 F.3d 1013 (D.C. Cir. 2014). 12 31 CFR 10.2(a)(2) and 10.3(b). 13 Chief Counsel Memo dated April 8, 2008, 210 TNT 169-53.


As a result, a license to practice accountancy as a “public accountant” or “registered accountant” may or may not confer eligibility to practice before the IRS under Circular 230, depending on the rules of the state granting that status. For example, the IRS has held that non-CPAs who hold licenses as public accounts in the following states meet the Circular 230 definition: Alabama, Alaska, Arkansas, California, Colorado, Connecticut, Idaho, Maine, Montana, New York, North Dakota, Oklahoma, Rhode Island, Tennessee, Vermont, and West Virginia. On the other hand, public accountants in Kansas and Iowa do not meet the definition unless they also hold a CPA license. Michigan law distinguishes between “registered CPAs” and “licensed CPAs.” Under Circular 230, only the members of the latter group are eligible to practice before the IRS. In Oregon, any person who holds a public accountant’s license and who qualified for, and applied to take, the Uniform CPA examination before January 1, 2002, is eligible to practice before the IRS. However, a person who holds an Oregon public accountant’s license, but who has not qualified for, or applied to take, the Uniform CPA examination before January 1, 2002, is not eligible to practice before the IRS. As with attorneys, persons qualifying to practice under the CPA criteria must generally file a written declaration with the IRS that the person is currently qualified as a CPA (or its equivalent, as noted above) and is authorized to represent the party or parties on whose behalf he or she acts. Just as with respect to attorneys, Form 2848, Power of Attorney and Declaration of Representative, satisfies this requirement. Similarly, a license to practice accountancy issued in, or by, a foreign jurisdiction does not confer eligibility to practice before the IRS. If a person is eligible to practice before the IRS under the CPA criteria, he or she may represent taxpayers located in any United States jurisdiction with respect to all matters administered by the IRS.

B. Enrolled Agents Circular 230 authorizes OPR to grant the status of “enrolled agent” to those individuals who demonstrate “special competence in tax matters.” Qualification as an enrolled agent may be obtained by either successfully completing a written exam or by completing an experience requirement as an IRS employee.14

C. Enrolled Actuaries Federal labor law established the Joint Board for the Enrollment of Actuaries (“JBEA”) which by regulation establishes reasonable standards and qualifications for individuals performing actuarial services with respect to employee plans governed by the Employee Retirement Income Security Act of 1974 (“ERISA”).15 The JBEA consists of three members appointed by the Secretary of the Treasury, two members appointed by the Secretary of Labor and one non-voting representative appointed by the Executive Director of the Pension Benefit Guaranty Corporation (“PBGC”). An individual who is enrolled as an actuary by the JBEA and who is not currently under suspension or disbarment may practice before the IRS by filing a written declaration stating that he or she is currently qualified as an enrolled actuary and is authorized to represent the party or parties on whose behalf he or she acts. As with other practitioners, a properly completed Form 2848, Power of Attorney and Declaration of Representative, suffices for the declaration. 14 31 CFR 10.4. 15 29 USC 1242(a).


An enrolled actuary must maintain active status as an actuary to practice before the IRS; those with inactive or terminated status are prohibited from doing so. Furthermore, enrolled actuaries are concurrently subject the disciplinary jurisdiction of both the JBEA and OPR. Unlike attorneys, CPAs, and most enrolled agents, the practice of enrolled actuaries before the IRS is limited. Specifically, enrolled actuaries may only represent taxpayers before the IRS with respect to twenty-one designated Code provisions concerning employee plans. Those provisions are as follows:

401 (qualification of employee plans); 403(a) (annuity plan requirements of §404(a) (2)); 404 (deductibility of employer contributions); 405 (qualification of bond purchase plans); 412 (funding requirements for certain employee plans); 413 (collectively bargained plans and multi-employer plans); 414 (definitions and special rules); 419 (treatment of funded welfare benefits); 419A (qualified asset accounts); 420 (transfers of excess pension assets to retiree health accounts); 4971 (excise taxes payable as a result of an accumulated funding deficiency); 4972 (tax on nondeductible contributions to qualified employer plans); 4976 (taxes with respect to funded welfare benefit plans); 4980 (tax on reversion of qualified plan assets to employer); 6057 (annual registration of plans); 6058 (information required in connection deferred compensation plans); 6059 (periodic report of actuary); 6652(e) (failure to file annual registration and other notifications by pension plan); 6652(f) (failure to file deferred compensation information); 6692 (failure to file actuarial report); and 7805(b) (retroactive effect of IRS rulings and determination letters).

Additionally, enrolled actuaries may represent taxpayers before the IRS in regard to the labor law provisions of 29 U.S.C. § 1083 (relating to the waiver of funding for nonqualified plans). Enrolled actuaries may represent taxpayers located in any United States jurisdiction, subject to the limited subject areas set forth above.

D. Enrolled Retirement Plan Agents A relatively new category of practitioner is the enrolled retirement plan agent. An enrolled retirement plan agent may represent taxpayers before the IRS only with respect to matters involving: (i) the employee plans determination letter program; (ii) the employee plans compliance resolution system; (iii) the employee plans master and prototype program and volume submitter program; and (iv) Form 5300 and Form 5500 filings (except with respect to actuarial forms or schedules).16 Like a regular enrolled agent, status as an enrolled retirement plan agent may be obtained through successful completion of a written exam or by meeting an IRS employee experience requirement. Like the SEE, the Enrolled Retirement Plan Agent Special Enrollment Exam (“ERPA SEE”) is administered on behalf of the IRS by a private organization, in this case the American Institute of Retirement Education, LLC.

16 31 CFR 10.3(e)(2).


The ERPA SEE consists of two parts containing multiple choice questions. The first part covers compliance and operations issues involving retirement plans. Specific topics might include participation, vesting, benefit formulas, nondiscrimination rules, and ADP/ACP testing. Part two deals with plan documents, reporting, and distribution issues, such as participant communications, rollovers, QDROs, and plan audit and correction programs. Each part of the exam is offered twice a year during two examination windows (one in the winter and one in the summer), each lasting approximately six to eight weeks. Just as with the SEE, the ERPA SEE is administered by computer at Prometrics testing sites throughout the country and abroad. Scoring of the ERPA SEE is similar to the SEE, with scaled scores are determined by calculating the number of questions answered correctly to the total number of questions in the examination and converting to a scale that ranges from 40 to 130. As with the SEE, the IRS has set the scaled passing score at 105. After passing both parts of the ERPA SEE the candidate must file Form 23‐EP, Application for Enrollment to Practice Before the Internal Revenue Service as an Enrolled Retirement Plan Agent (ERPA). In addition to qualifying by successfully completing the ERPA SEE, an enrolled retirement plan agent may qualify as a practitioner by virtue of prior IRS employment experience. As discussed above with respect to enrolled agents, a minimum of five years of continuous employment with the IRS is generally required, although that requirement will be deemed to have been met if the applicant has an aggregate of ten years IRS employment, at least three of which have occurred within the five years ending on the application date. With respect to enrolled retirement plan agents, the position held must be one in which the employee was regularly engaged in applying and interpreting the provisions of the Code and regulations specifically with respect to qualified retirement plan matters.17 If relying on experience for qualification, Form 23-EP must be filed within three years from the last date of employment with the IRS. As with enrolled agents, candidates are subject to a background check for tax compliance before the application can be approved. Similarly, an enrolled retirement plan agent will not be recognized as a representative unless he or she is appointed as an attorney-in-fact on a properly completed Form 2848, Power of Attorney and Declaration of Representative. As noted above, the practice of enrolled retirement plan agents before the IRS is limited to certain issues involving retirement plans. Only enrolled retirement plan agents in active status are eligible to practice before the IRS, and if an enrolled retirement plan agent is eligible to practice before the IRS, he or she may represent taxpayers located in any United States jurisdiction, but only with respect to those matters specifically involving retirement plans.

E. Appraisers The IRS does not itself provide any authorization or credentialing for appraisers. Although appraisers may present evidence or testimony in administrative proceeding before the Department of the Treasury or the IRS, this does not confer eligibility to practice before the IRS generally. However, OPR may take disciplinary actions with respect to appraisers.

17 31 CFR 10.4(c)(5).


Specifically, Circular 230 authorizes OPR to institute a proceeding for disqualification against any appraiser who has been assessed a penalty for aiding and abetting an understatement of tax liability under Code §6701(a). If an appraiser is so disqualified, he or she is thereafter barred from presenting evidence or testimony in any IRS administrative proceedings, even in circumstances where the evidence or testimony pertains to an appraisal made prior to the effective date of disqualification. An appraisal made by a disqualified appraiser after the effective date of disqualification does not have any probative effect in any administrative proceeding before the IRS. However, such appraisal may be admitted into evidence solely for the purpose of determining the taxpayer’s reliance in good faith on the appraisal. Once five years has elapsed since the date of disqualification, however, an appraiser may file a written petition with OPR seeking reinstatement. OPR may grant reinstatement if the appraiser demonstrates that he or she is not likely to violate the standards of practice contained in Circular 230 and that granting reinstatement would not be contrary to the public interest.18

F. Annual Filing Season Program Participants This new voluntary program recognizes the efforts of return preparers who are generally not attorneys, certified public accountants, or enrolled agents. The IRS issues an Annual Filing Season Program Record of Completion to return preparers who obtain a certain number of continuing education hours in preparation for a specific tax year. Annual filing season program participants do not have unlimited practice rights (unless they are also an attorney, certified public accountant, or enrolled agent). Their representation rights are limited to clients whose returns they prepared and signed, but only before revenue agents, customer service representatives, and similar IRS employees, including the Taxpayer Advocate Service. They cannot represent clients whose returns they did not prepare, nor can they represent clients regarding collection or appeals matters. Any tax return preparer who does not fall into one of the categories described above has limited representation rights only until December 31, 2015. Effective January 1, 2016, other tax return preparers will have no representation rights. Only return preparers who participate in the Annual Filing Season Program will have limited representation rights. Other tax return preparers, of course, may still provide return preparation services.

IV. Continuing Professional Education Practitioners who qualify to represent taxpayers before the IRS by virtue of enrollment as enrolled agents or enrolled retirement plan agents must comply with continuing professional education (“CPE”) requirements. Although attorneys and CPAs are not subject to the CPE requirements of Circular 230, most states’ licensing bodies separately require CPE for these professionals. The Circular 230 CPE requirements are based on the three-year “enrollment cycle.” A minimum of 72 hours of CPE must be completed within each enrollment cycle. Additionally, the enrolled agent (or enrolled retirement plan agent) is prohibited from “bunching” these hours into a single year. Rather, for each calendar year within the enrollment cycle, the practitioner must complete at least 16 hours, including 18 31 CFR 10.81.


two hours in course work related to ethics or professional conduct. For practitioners who are enrolled in the middle of an enrollment cycle, two hours of CPE must be completed for each month (or part of a month) of enrollment during the enrollment cycle, including two hours of courses in ethics or professional conduct for any calendar year (or part of a calendar year) of enrollment.19 Qualifying CPE courses must be sponsored by an organization that has received approval from OPR to present such courses. Credit is available for live courses, as well as correspondence and web-based courses. Furthermore, under the pre-2010 amended version of Circular 230, credit can be obtained for acting as the instructor of an approved course and for publishing books and articles, provided no more than 50 percent of the required credits may be obtained from serving as an instructor and no more than 25 percent from publication activities. The 2010 amendments would limit credits from instruction activities to four hours annually and would eliminate the ability to obtain credit for publication activities.

V. PTINS Paid tax return preparers have always been required to sign the returns they prepare and provide a tax identification number, either their social security number or a special Practitioner Tax Identification Number (“PTIN”) issued by the IRS. Beginning with any returns filed after December 31, 2010, return preparers are prohibited from using their social security number and must instead use a PTIN. PTINs that were previously issued must be re-registered. A PTIN must be obtained by all enrolled agents, as well as all tax return preparers who are compensated for preparing, or assisting in the preparation of, all or substantially all of any U.S. federal tax return, claim for refund, or other tax form submitted to the IRS. PTINs are not required for the preparation of an Application for Employer Identification Number (Form SS-4), Application for Change in Accounting Method (Form 3115), or a variety of information reports, such as W-2s and 1099s. For example, suppose you hire paid interns during filing season to perform data entry from tax organizers that clients fill out and assemble the documentation that the clients submit. Where clients have submitted incomplete information, or more information is needed, the interns may call clients to gather information missing from the tax organizer, but they are not allowed to provide advice or answer tax law questions. Under these circumstances the interns would not be considered preparers and would not need a PTIN. But suppose the interns are allowed to work on and sign simple forms, such as the 1040EZ. That would make them preparers subject to the PTIN requirements. Signing the return, however, is not a litmus test. Rather, all of the facts and circumstances have to be considered. An individual who actually prepares the return only to have another practitioner sign it is undoubtedly subject to the PTIN requirements. A PTIN is not the same as an Electronic Filing Identification Number (EFIN). A PTIN is a number issued by the IRS to paid tax return preparers. It is used as the tax return preparer’s identification number and, when applicable, must be placed in the Paid Preparer section of a tax return that the tax return preparer prepared for compensation. There is an initial fee of $64.25 and an annual renewal fee of $63.00. An EFIN is a number issued by the IRS to individuals or firms that have been approved as authorized IRS e-file providers. It is included with all electronic return data transmitted to the IRS. There is no fee for an EFIN. PTINs are issued to individuals, while EFINs may be issued to individuals or firms. Most preparers need both.

19 31 CFR 10.6(e).


Note that the Freedom of Information Act of 2016 requires the IRS to release certain information about people who hold PTINs and enrolled agents. The information includes the PTIN holder’s name, business name, mailing address, phone number, website, e-mail address, and professional credentials (see the IRS webpage, “FOIA Awareness for PTIN Holders”). The IRS says that PTIN holders may now use P.O. boxes for their business mailing address. It also said that if a practitioner used a personal address instead of a business address, or used a street address instead of a P.O. box, he or she may want to change it. It also advised practitioners who receive unwanted solicitations to report the problem to the Federal Trade Commission.

VI. Sanctions Federal law provides that the Internal Revenue Service (“IRS”) (pursuant to authority granted to the Secretary of Treasury by statute)20 may impose certain sanctions against individuals who practice before the agency under certain circumstances. Before doing so, the agency must provide the individual with notice of the proposed sanction and an opportunity to participate in an administrative hearing.21 The rules of conduct applicable to those who practice before the IRS are contained in Treasury regulations found at in the Code of Federal Regulations at 31 C.F.R. part 10. These regulations are also published in a pamphlet referred to as “Treasury Department Circular No. 230,” more commonly referred to as simply “Circular 230.” Circular 230 also proscribes specific rules regarding the imposition of sanctions against those as to whom violations of its standards have been alleged. The IRS Office of Professional Responsibility (“OPR”) is responsible for pursuing disciplinary action against those who transgress the rules of Circular 230. If OPR decides to institute formal disciplinary proceedings, a disciplinary hearing governed by the Administrative Procedures Act is held before an administrative law judge (“ALJ”). The Office of the Associate Chief Counsel (General Legal Services) represents OPR in any such proceedings. The Tax Division of the Department of Justice may also take action against an individual for violations of Circular 230, most often seeking an injunction in a U.S. District Court under the authority of Internal Revenue Code (“Code”) §7408.22

A. Types of Sanctions Four different sanctions are authorized: censure, suspension, disbarment, and monetary penalties.23 Censure is a public reprimand,24 usually accomplished by a notice published in the Federal Register. Suspension from practice before the IRS may be imposed for an indefinite duration or for a specified period of time. Disbarment, of course, is permanent, although someone who has been disbarred may petition OPR for reinstatement after waiting a period of five years following the disbarment.25 Unlike disbarment or suspension, censure does not per se impact the individual’s ability to practice before the IRS. However, once an individual is censured, OPR may impose conditions on that individual’s practice activities for a reasonable period of time in light of the gravity of the practitioner’s violations.

20 31 U.S.C. § 330. 21 Id. at (b). 22 26 U.S.C. §7408(c). 23 31 U.S.C. § 330.. 24 31 C.F.R. § 10.50(a). 25 Id. at §10.81.


Likewise, conditions may be imposed on an individual after a period of suspension has expired. For example, if the censure or suspension resulted from a failure to obtain the clients’ written consents regarding potential conflicts of interest, OPR may require the practitioner to provide a copy of all consents obtained by the practitioner for an appropriate period following the sanction.26 The authority to impose the sanctions of censure and monetary penalties were both added to OPR’s arsenal with the passage of the American Jobs Creation Act of 2004,27 and thus apply only with respect to prohibited conduct that occurs after October 22, 2004, the date of enactment.28 Monetary penalties may be imposed for a single act of prohibited conduct or for a pattern of misconduct, and may be imposed in addition to, or in lieu of, any suspension, disbarment, or censure of the practitioner.29 There is no set or standard penalty amount. Rather, the law provides that monetary penalties can be imposed up to the amount of gross income derived (or anticipated to be derived) from the conduct giving rise to the penalty.30 The specific amount of any monetary penalty imposed, subject to the limits described above, is left to the discretion of OPR. Furthermore, not only can OPR impose a penalty on the individual whose conduct ran afoul of Circular 230, a monetary penalty may also be levied against that person’s firm or employer if it is determined that the firm or employer knew, or reasonably should have known, of the prohibited conduct.31 While public censure has been used in a few cases, no reported cases to date involve the actual imposition of a monetary penalty. Being proactive and responding responsible way to allegations of Circular 230 infractions is an entity’s best defense against monetary sanctions. All firms whose employees or members practice before the IRS should require that the practitioners be familiar with any developments regarding Circular 230 through continuing professional education or otherwise. Once an allegation is made, the firm or employer should conduct its own investigation, isolate the circumstances that allowed the alleged infraction to occur, and take appropriate remedial actions to prevent a recurrence. The most common sanction is suspension. Of the 163 disciplinary cases reported in 2010, only two resulted in censure and five in disbarment. The vast majority, representing over 93 percent of the cases, resulted in a suspension. Of those, most resulted from default decisions; annually, only about 25 percent (20-40 cases per year) actually go through the hearing process.

B. Increased Sanctions Upon Appeal In determining whether or not to appeal a sanction, practitioners are well advised to carefully consider their options. One reason is that on appeal, the Office of Chief Counsel can not only uphold or overturn the ALJ’s decision, it can actually increase the sanction imposed by the ALJ.32 CPA Martin Chandler learned this the hard way. 26 31 C.F.R. § 10.79(d). 27 Pub. L.108-357, 118 Stat. 1418, 1587. 28 IRS Notice 2007-39. 29 31 U.S.C. § 330. 30 Id. 31 IRS Notice 2007-39. 32 31 CFR § 10.78 provides that “issues that are exclusively matters of law will be reviewed de novo.” Since the permissible

sanctions are identified in the statute and regulations, they are matters of law. See OPR v. Llorente, Complaint No. 2008-03 at 3 (decision on appeal, Apr. 10, 2009) (increasing a suspension penalty to disbarment because the practitioner had a pattern of failing to file federal income tax returns).


Chandler failed to file his federal income tax returns for 2000, 2001, and 2003. OPR filed a Complaint seeking a 36 month suspension. When it was learned that Chandler had, in fact, paid his tax liability, OPR amended its Complaint to seek a sanction of only 33 months.33 The ALJ agreed with OPR that Chandler’s failure to file was sanctionable conduct, although Chandler argued that he did not believe he had any tax liability and was therefore not required to file, an argument that both the ALJ and the Office of Chief Counsel found less than compelling. The ALJ did find, however, that the requested sanction was too harsh. Given the fact that Chandler was 72 years old and had paid his tax liability, the ALJ felt it was proper to reduce the suspension to 18 months. Martin Chandler was not happy with this result. He appealed to the Office of Chief Counsel, which viewed his case very differently. Chief Counsel felt that Chandler had not taken appropriate responsibility for his actions, that he considered the failure to file returns to be “no big deal” or some sort of “foot fault.” Chandler’s age, in Chief Counsel’s opinion, should have no effect absent some added showing of mental or physical disability. As a result of the appeal, Chief Counsel determined that a more appropriate sanction would be 36 months suspension, and that was the term of the suspension imposed in the final agency decision. An even harsher lesson was learned by Harold Hurwitz. When served with a Complaint alleging a failure to file for five years, Hurwitz responded that he was “painfully aware of the legalities” as to the timely filing of returns, but he intended to file as soon as he could. Asserting that his late filings were not willful and were due to health problems, among other things, he pointed out that he had subsequently filed the returns and paid all amounts due.34 OPR sought a sanction of 36 months’ suspension, which was granted by the ALJ. Feeling that a punishment of that length was not justified, Hurwitz appealed to Chief Counsel. The Chief Counsel agreed that a suspension of 36 months was inappropriate. Unfortunately for Hurwitz, Chief Counsel felt disbarment was a more appropriate sanction and the final agency decision was changed to disbarment.35

C. The Process for Imposing Sanctions Whatever sanction imposed, it generally results from a formal hearing that commences with a Complaint served on the practitioner and resembles civil litigation. The Complaint must specify the sanction being sought and the practitioner must file a written answer. An ALJ conducts an evidentiary hearing and issues a decision imposing the sanction sought or a lesser penalty. Either party may appeal the ALJ’s decision to the IRS Office of Chief Counsel (which is located outside of the IRS, but within the Treasury Department). If appealed, the Office of Chief Counsel may uphold the sanction, overturn it, modify it (including increasing it, as noted above), or remand the case to the ALJ for further fact development. Either party may further appeal the decision of the Office of Chief Counsel to the U.S. District Court, where the ALJ and Office of Chief Counsel decisions will be reviewed using an “abuse of discretion” standard, meaning it will only be overturned if the federal judge determines that the decision was “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law” or “unsupported by substantial evidence.”36 If

33 OPR v. Chandler, Complaint No. 2006-23 (Decision on Appeal dated 4/2008). 34 OPR v. Hurwitz, Complaint No. 2007-12 (Motion for Summary Judgment dated 6/9/08). 35 Id. (Decision on Appeal dated 4/21/09). 36 APA § 706(2).


no appeal is filed within 30 days of the ALJ or Office of Chief Counsel decisions, however, that decision becomes final. If the practitioner fails to file an answer, he or she is deemed to have admitted the allegations contained in the Complaint and waived the right to a hearing.37 As such, OPR will file a motion for a default decision. Assuming no response to the motion is filed within 30 days, the practitioner will be deemed not to oppose the motion and the ALJ will issue its decision based on the information contained in the Complaint.38 Under certain circumstances a practitioner may be suspended from practicing before the IRS pursuant to a conference with OPR rather than a hearing before an ALJ. These so-called “expedited hearing” suspensions are authorized by Circular 230 when the practitioner has: (i) had a his or her professional license suspended or revoked for cause (other than for a failure to pay a professional licensing fee); (ii) been convicted of any tax crime, any crime involving dishonesty or breach of trust, or any felony for which the conduct involved renders the practitioner unfit to practice before the IRS; (iii) violated conditions previously imposed on the practitioner by OPR; or (iv) been sanctioned by a court of competent jurisdiction relating to any taxpayer’s tax liability or relating to the practitioner’s own tax liability, for: (a) instituting or maintaining proceedings primarily for delay; (b) advancing frivolous or groundless arguments; or (c) failing to pursue available administrative remedies.39 The majority of sanctions are imposed in this manner. Of the 183 practitioners subject to sanctions imposed during 2010, for example, 134, or approximately 73 percent were the result of an expedited hearing process. The majority of those cases were defaulted by the practitioner, meaning that no defense was presented. In only four instances was the sanction imposed by consent. Although the expedited hearing procedure is sometimes instituted when a practitioner has been convicted of a crime, in the vast majority of circumstances it is used as a result of the revocation or suspension of the professional license of an attorney or CPA. In lieu of a disciplinary proceeding being instituted or continued, an individual may consent to a specific sanction. Typically, an offer of consent will provide for: suspension for an indefinite term; conditions that the individual must observe during the suspension; and the individual's opportunity, after a stated number of months, to file a petition for reinstatement affirming compliance with the terms of the consent and affirming current eligibility to practice (i.e., an active professional license or active enrollment status). An enrolled agent or an enrolled retirement plan agent may also simply offer to resign in order to avoid a disciplinary proceeding. A disciplinary hearing under Circular 230 is a serious matter and is governed by specific rules of evidence and procedure. Practitioners, even those who are themselves attorneys, are well advised to consult with legal counsel familiar with this process. The practitioner may want to check with his or her malpractice or general insurance carrier; often these policies will cover the cost of legal representation. An additional route that may be used against an errant practitioner is an injunction imposed by a federal district court. Injunctions are handled by attorneys in the Tax Division of the Department of Justice and may be pursued in lieu of, or in addition to, sanctions sought by OPR.

37 31 C.F.R. §10.64(d). 38 Id. at §10.68(b). 39 Id. at §10.82.


VII. Conduct Giving Rise to Sanctions

A. Standards There are four (and only four) circumstances in which Congress has statutorily authorized the imposition of sanctions. Those circumstances are when an individual is found to be “incompetent” or “disreputable,” violates the provisions of Circular 230, or willfully and knowingly misleads or threatens his or her client with the intent to defraud.40 While the statute specifies the type of conduct that is subject to sanction, Circular 230 sets forth the characterization of the conduct that will result in the imposition of sanctions. Under this approach, sanctionable conduct must generally be “willful.” The term “willful” has been interpreted to mean the voluntary, intentional violation of a known legal duty. Thus, in most cases, inadvertent violations of Circular 230 will not result in sanctions.41 However, OPR does not have to make a showing of malicious intent or bad purpose, only that the accused purposefully disregarded or was indifferent to his or her obligations.42 However, willfulness is not required when the alleged impropriety involves: (i) frivolous positions or positions used to for primarily for delay; (ii) failing to advise a client of reasonably likely penalties related to a position taken on a return; or (iii) written advice. With respect to these three categories of conduct OPR does not have to show that the practitioner acted willfully, but only that the practitioner acted recklessly or with gross incompetence.43 Gross incompetence focuses on the practitioner’s attention to client matters and preparation. Such conduct would include actions that reflect gross indifference to the law or facts or a consistent failure to perform obligations to the client. Also, the failure to adequately prepare under the circumstances can be considered gross incompetence.44

B. Incompetence and Disreputable Conduct Circular 230 does not differentiate between the concepts of “incompetence” and “disreputable conduct,” but rather provides a laundry list of fifteen specific instances that fall under those general concepts. This list is intended to be illustrative rather than comprehensive45 and “disreputable conduct” is meant to include “any conduct that is violative of the ordinary standard of professional obligation and honor.”46 The list of incompetent or disreputable activities contained in §10.51 of Circular 230 includes:

Conviction of any criminal offense under federal tax law; Conviction of any criminal offense involving dishonesty or breach of trust; Conviction of a felony rendering the practitioner unfit to practice before the IRS; Giving false or misleading information to federal tax authorities; Indicating that special treatment can be obtained from the IRS; Willfully failing to file a federal return or pay federal taxes; Willfully assisting, counseling, encouraging the violation of federal tax law;

40 31 U.S.C. §330(b). 41 See United States v. Bishop, 412 U.S. 346 (1973); United States v. Pomponio, 429 U.S. 10 (1976); Cheek v. United

States, 498 U.S. 192 (1991); United States v. Boyle, 469 U.S. 241 (1985). 42 OPR v. DeLiberty, Complaint No. 2007-08, (Default on Motion for Summary Judgment dated 9/11/07). 43 31 CFR §§ 10.34-10.37. 44 31 C.F.R. § 10.51(a)(13). 45 Joslin v. Secretary of Dep’t of the Treasury, 832 F.2d 132, 134 (10th Cir. 1987). 46 Poole v. U.S., Docket No. 84-0300, 1984 U.S. Dist. LEXIS 15351, at *7 (D.D.C. June 29, 1984).


Mishandling funds received from a client for the payment of taxes; Threats, false accusations, duress, coercion, or bribery of an IRS employee; Disbarment or suspension from practice by any state or by a federal agency; Knowingly assisting another who is suspended or disbarred from practice; Using abusive, malicious, or libelous language in a matter before the IRS; Inappropriate actions regarding the issuance of opinions; Willfully failing to sign a tax return prepared by the practitioner; and The inappropriate and willful disclosure or use of tax information.

C. Criminal Convictions Involvement in a civil litigation, such as a bankruptcy, divorce, and even a malpractice claim will not in and of itself give rise to sanctions under Circular 230. It is certainly possible, however, that the facts and circumstances underlying such civil actions could constitute incompetence or disreputable conduct resulting in sanctions. Likewise, mere arrest or indictment on a criminal charge will not result in sanctions. However, three categories of criminal convictions are specifically deemed to constitute disreputable conduct. Those categories are: (i) conviction of any federal tax crime; (ii) conviction of any crime involving dishonesty or breach of trust; and (iii) any felony conviction rendering the practitioner “unfit to practice before the IRS.”47 “Dishonesty” encompasses the act or practice of cheating, deceiving, defrauding, lying, or stealing.48 Ordinarily, the statutory elements of a crime will indicate whether it is one of dishonesty.49 Criminal offenses such as identity theft,50 bribery,51 housebreaking,52 larceny,53 forgery,54 fraud,55 and collection of extensions of credit by extortionate means56 have all been characterized as crimes of dishonesty. “Breach of trust” crimes generally involve the abuse of some relationship of trust or the fraudulent acquisition of property by using a position of trust for personal gain and may include embezzlement57 or larceny.58 Some courts have even characterized certain sex crimes as a breach of trust by a caregiver.59 The third category of criminal conviction constituting disreputable conduct under Circular 230 (felonies rendering the practitioner “unfit to practice before the IRS”) is the most subjective and least well defined. Perhaps the only thing certain about this category is that it does not encompass misdemeanors. In 2009 attorney James J. Everett asserted that the term “conviction” as used in Circular 230 means only a “final” disposition after the exhaustion of all appeals. Everett was an attorney who had practiced law in both Arizona and Texas. He filed a Chapter 7 bankruptcy petition in 2002 and received a discharge of more than $450,000 in liabilities the following year.60 47 31 CFR §§ 10.52(a)(1)-(3). 48 Morris v. State, 795 A.2d 653, 665 (Del. 2002). 49 See Fed.R.Evid. 609. 50 Goudge v. Astrue, Slip Copy, 2010 WL 4007538, D.Or., October 12, 2010 (NO. CIV. 09-1170-HA). 51 United States v. Jefferson, 623 F.3d 227 (5th Cir., 2010). 52 State v. Cooper, 687 S.E.2d 62 (S.C.App., 2009). 53 Id. 54 State v. Brooks, 2009 WL 3463924, Ariz.App. Div. 1, October 27, 2009 (NO. 1 CA-CR 08-0875). 55 Id. 56 Pennsylvania v. Cascardo, 981 A.2d 245 (Pa. Super 2009). 57 State v. Jackson, 527 S.E.2d 367 (S.C.App., 2000). 58 State v. Parris, 578 S.E.2d 736 (S.C.App., 2003). 59 People v. Torres, 2001 WL 1200857, Cal.App. 1 Dist., October 10, 2001 (NO. A090804). 60 OPR v. Everett, Complaint No. 2009-27 (Decision dated 7/22/10).


As it turns out, two months prior to filing the bankruptcy petition Everett had arranged a lease-purchase agreement for a house in Paradise Valley, Arizona, paying $5,500 in monthly rent. He later purchased the house (approximately 19 months after the bankruptcy discharge) for over a million dollars.61 These transactions lead to further investigation that resulted in Everett being charged in a 34 count indictment with, among other things, making false declarations in his bankruptcy proceeding by concealing his interest in a corporation, his lease, two bank accounts, and interest in his deceased mother’s estate. He was also charged with devising a scheme to defraud the bankruptcy court by concealing property. He was found guilty on all but one count.62 On June 17, 2009, OPR filed a Complaint against Everett alleging that his criminal convictions constituted incompetence or disreputable conduct and rendered him unfit to practice before the IRS and sought to have him disbarred.63 Everett filed an Answer to the Complaint asserting that he had appealed the convictions and requesting that the disciplinary proceeding be stayed pending the outcome of the appeal. Because the convictions could be overturned on appeal, he argued that they could not serve as a basis for his disbarment.64 Furthermore, Everett noted that he had never been the subject of disciplinary proceedings before in the many years he had practiced before the IRS and that the allegations underlying his criminal convictions emanated from his personal affairs and not his conduct as a practitioner before the IRS. OPR disagreed, taking the position that a trial conviction was a sufficient basis for sanction, regardless of any pending appeals.65 The ALJ granted OPR’s motion for summary judgment, concluding that OPR had sufficiently established that Everett had engaged in “incompetence and disreputable conduct,” by virtue of his conviction of crimes involving dishonesty or breach of trust. The ALJ denied OPR’s request for the imposition of a sanction, however, and scheduled a hearing to address the remaining issue of the appropriate sanction to impose against Everett. The hearing was subsequently stayed pending a decision on Everett’s appeal of his criminal convictions.66 Presumably, if Everett’s convictions had been overturned OPR would have been denied its request for disbarment. Unfortunately, the Ninth Circuit affirmed Everett’s conviction and specifically affirmed the jury’s finding that Everett created a corporation to conceal assets from the bankruptcy court and to facilitate the lease and purchase of the house. Everett had no further contact with OPR or the ALJ concerning his disciplinary hearing and he was disbarred by default pursuant to a motion for summary adjudication filed by OPR.67

D. Tax Protestors and Tax Shelter Promoters Incompetence may also arise from adopting so-called “tax protester” positions. These are well-refuted positions based on a strained and unsupported interpretation of the law, such as the standard tax protestor position that the federal income tax is illegal because the Sixteenth Amendment to the United States Constitution was not ratified.68

61 Id. 62 Id. 63 Id. 64 Id. 65 Id. 66 Id. 67 Id. 68 See, e.g., OPR v. Banister, No. 2003-2 (Decision dated 6/25/04).


Other equally fanciful tax protester positions include arguments that the authority of the federal government is confined to the geographic limits of the District of Columbia, the term “income” as used in the Code is unconstitutionally vague and indefinite, only receipt of gold and silver can be constitutionally taxed, and only federal government employees are subject to federal taxation. Courts have addressed and uncontrovertibly emasculated each of these arguments, but some taxpayers and, it appears, some practitioners persist in using them. In a high profile case involving California CPA and former IRS Criminal Investigations Special Agent Joseph Banister, OPR made it clear that use of frivolous tax protester arguments may result in disbarment from practice.69 Disbarment may also result from the promotion of abusive tax shelters. In 1992 Thomas Settles, an attorney and CPA, began developing a tax strategy involving the transfer and lease of a taxpayer’s “goodwill” as well as the setting up of related entities such as living trusts, limited partnerships and management companies. Under this strategy the taxpayer would transfer his or her “goodwill,” residence and automobiles to a living trust of which the taxpayer was the trustee.70 The trust would then transfer the “goodwill,” the residence and sometimes the automobiles to a family limited partnership (“FLP”) consisting of the taxpayer, spouse, any children and a general partner. The spouse and children would contribute nothing to the partnership for their partnership interest. A corporation owned by the taxpayer was set up as the general partner of the FLP with a one percent interest (the “management company”).71 The FLP would then pay the management company a management fee for managing the assets and the management company would hire the taxpayer, his spouse and children as employees of the company. The taxpayer would concurrently enter into a facilities fee arrangement with the FLP to rent back his “goodwill,” residence and automobiles; deducting the rent expense on his or her tax return. The facilities fee would be reported as income by the FLP, but would be reduced by the personal living expenses of the family. The management company would pay its employees a salary in the form if tax free fringe benefits, such as health insurance, split dollar life insurance and tuition reimbursement; and any of the rent income to the FLP that was not reduced by the facilities fee payment would be distributed as income to the family members.72 In 1998, Settles began selling this tax strategy to his clients. In 2000, he set up a website providing income tax planning information to his clients and the public. A Final Judgment of Permanent Injunction was entered by the United States District Court against Settles on March 24, 2003. In it, Settles was enjoined from organizing, promoting, marketing or selling his tax strategy. In addition, OPR filed a Complaint seeking that Settles be disbarred from practice before the IRS, a request that was granted by the ALJ’s decision on March 2, 2006.73

E. Laziness Leading to Sanctions for Incompetence and Disreputable Conduct Nevada attorney Alan Jones runs what appears to be a thriving tax controversy practice in Las Vegas where he maintains a website in which he advertises his practice as “American Tax Payers Defense.” The

69 OPR v. Banister, No. 2003-2 (Decision dated 6/25/04). Banister was later indicted on felony charges, but was acquitted by

a California jury. 70 OPR v. Settles, Complaint No. 2004-11 (Decision dated 3/2/06). 71 Id. 72 Id. 73 Id.


website contains testimonials, such as one which reads: “I could have faced time in jail for this. My kids could have been without their father. Alan Jones and his plan saved me.”74 In 2005, the website identified Jones and two employees as principals in the firm with Jones listed as president and other employees listed as an “Enrolled IRS Agent” and an “IRS enrolled agent,” respectively. He routinely had two of his employees sign and file IRS Form 2848 (power of attorney) as enrolled agents. The problem was that the employees in question were not enrolled agents. The defense asserted by Jones when OPR charged him with incompetence and disreputable conduct confirmed that his procedures were rooted in convenience, so that the employees could deal with the IRS directly in assisting clients.75 Apparently with the same motivation, Jones was found to have signed and filed with the IRS several powers of attorney (Forms 2848) that the named taxpayers had not signed, but whose signatures had been “cut and pasted” onto the form.76 In imposing a suspension of two years, the ALJ noted that Jones’s violations did not appear to be motivated by fraud or any evil intent. Rather, his actions seemed to be borne out of sheer laziness. “He would rather . . . his office manager misrepresent her status to the IRS than suffer the inconvenience of speaking to the IRS himself when arranging a conference or hearing for a client,” noted the ALJ. “He would rather have signatures of clients cut and pasted onto forms rather than suffer the inconvenience of having the clients come to [his] office to sign the forms or mailing the forms to the clients for their signatures,” continues the opinion. Finally, the ALJ noted that Jones preferred to deceive the IRS and the public into believing that his employees were enrolled agents, “rather than suffer the inconvenience of requiring those persons to follow the regulations.”77

F. Use of Cancelation of Debt Reporting as a Form of Collection OPR recently addressed a question from a practitioner who proposed using Forms 1099-C as a collection technique with delinquent/non-paying clients. The practioner was the owner and operator of a small firm that provides various tax representation services for compensation. The firm usually enters into a written fee agreement with a client for the services agreed upon. For most clients, the firm does not require a retainer or the payment of fees in advance. The firm generally bills clients for the services after the fact, requesting payment within 30 days. Invoices unpaid after 30 days are considered delinquent and treated as subject to collection regardless of whether the client disputes the liability. The practitioner stated that the firm would periodically write-off balance-due amounts as uncollectible based on established criteria. As to amounts treated as non-collectible, the firm would like to complete and file Forms 1099-C identifying each such client as the “debtor” and reporting the unpaid account balance as the “amount of debt discharged” in Box 2 of the form. The firm would simultaneously send Copy B of the form to the client for purposes of reporting the discharged amount on the client’s income tax return(s). The goal would be to encourage the client to pay or make him/her report additional income for our “free” services. 74 www.acriminaltaxattorney.com. 75 OPR v. Jones, Complaint No. 2005-13 (ALJ Decision dated 1/16/07). It should be noted that Jones asserted that he

“considered” the employees to be enrolled agents. Also, the allegations as to one of the employees were dismissed because, although the employee was not an enrolled agent, the employee was a CPA entitled to represent taxpayers before the IRS.

76 Id. 77 Id.


In response, the OPR observed that a tax professional who prepares and submits any form to the IRS, including tax returns and information returns, whether for his or her own business purposes or on behalf of a client, should know the purpose of the form, the situations in which the form must or should be used, and the rules and instructions as to the time and manner for filing the form. A tax professional also should know the related state and federal laws, including applicable internal revenue provisions. If a tax professional repeatedly uses Forms 1099-C as a business strategy to collect unpaid fees, when the tax professional knows, or should know, that the facts and circumstances do not provide a basis for doing so, the conduct calls into question the tax professional’s fitness to practice before the IRS. A pattern of issuing Form 1099-C with a reckless disregard as to the existence of a debt (because, for example, the former client does not have a fixed contractual liability to repay a sum previously received), or the absence of an “identifiable event” triggering a reporting requirement, is inconsistent with the standards of competency and professionalism embodied in the rules of practice. A number of provisions concern responsibilities in connection with client communications. Section 330(b)(4) of Circular 230, for example, allows for discipline, after notice and proceeding, for a representative who, with intent to defraud, willfully and knowingly misleads or threatens the person being represented or a prospective person to be represented. Several provisions of Circular 230 also are relevant, and should be kept in mind. Section 10.22(a) of Circular 230 requires a tax professional to exercise due diligence in: (1) preparing and filing returns, documents, and other papers relating to IRS matters; (2) determining the correctness of oral or written representations made by the tax professional to the IRS; and (3) determining the correctness of oral or written representations made to clients. Section 10.35 requires tax professionals to “possess the necessary competence to engage in practice” before the IRS. To be competent, a tax professional must have the “appropriate level of knowledge, skill, thoroughness, and preparation necessary for the matter for which the practitioner is engaged.” Section 10.51(a)(4) identifies as “incompetence and disreputable conduct,” the giving of false or misleading information “to the Department of the Treasury or any officer or employee thereof.” The OPR did not specifically opine that the facts as described would constitute a violation of the law or regulations governing practice before the IRS. Such a determination is always a matter of facts and circumstances, including the presence or absence of conduct that was willful, grossly incompetent, or a reckless disregard of the rules and regulations. Additionally, nothing in their answer should be construed as suggesting a violation of the Internal Revenue Code, or any liability for a penalty under the Code. Practitioners must use an appropriate level of care and thought in submitting forms or other documents to the IRS or to a client, compatible with the letter and spirit of the regulations governing practice. They did note, however, that, while not directly within the OPR’s purview, the analysis of substantive law would be highly relevant to this fact pattern. As a matter of tax law, a discharge of indebtedness is generally gross income of the debtor, pursuant to §61(a)(12) of the Internal Revenue Code [and Treasury Regulation §1.61-12(a)]. Certain discharges of indebtedness are excluded from gross income (see Code §108). Whether there has been a discharge of debt that must be treated as income to a taxpayer, and the tax year in which the income is realized, are questions of fact. Whether there is a debt that can be discharged is also a question of fact, as it generally occurs when a taxpayer receives funds that are not includible in income because the taxpayer is obligated to repay the obligation at a later date. Code §6050P, which establishes the requirement to file an information return reporting a discharge of debt (Form 1099-C), is directed only at “applicable entities” and excludes from such reporting any discharge below $600. An “applicable entity” is defined as an “executive, judicial, or legislative agency” of


the United States or an “applicable financial entity,” such as a bank, savings and loan association, credit union, the FDIC, or “any organization a significant trade or business of which is the lending of money” [§6050P(c)]. The OPR concluded by stating that it would be difficult to conceive of a situation in which a tax professional, principally engaged in providing tax services will be an “applicable entity” justifying the use of Form 1099-C to attribute income to an arguably scofflaw client for the nonpayment. However, every case will depend on its own particular facts and circumstances, including the existence (or not) of “debt,” with the crux of the analysis turning on whether the client can be said to have received previously untaxed funds from an applicable entity for which there is an obligation for repayment.

VIII. What Kinds of Cases Result in Disbarment?

A. Distinction Between Disbarment and Suspension Disbarment is the most severe sanction that can be sought under Circular 230. Interestingly, the regulations do not provide any standards for determining when it is appropriate to order disbarment as opposed to suspension. Although it seems intuitive that a disbarment is distinct from a suspension, the sanctions have been confused by OPR and the ALJ in at least one case. In 2009 OPR sought to have attorney Jennifer K. Suits “disbarred for a minimum of 48 months.”78 The requested sanction was imposed without correction. Despite this confusion, there is a distinction between the two sanctions set forth in Circular 230. For example, if a practitioner is disbarred, he or she must wait at least five years before petitioning for reinstatement.79 Under this provision it is clear that there can be no “disbarment” lasting only 48 months and the sanction in Suits operates as a suspension, not a disbarment. It should be noted, however, that it is not unusual for an ALJ to impose a suspension for “an indefinite period” with a specified minimum period of suspension.

B. Disbarment for Failure to File Disbarment cases almost always involve a failure to file or pay personal tax obligations by the practitioner. Most often, the failure to file is the only transgression contained in the Complaint. It should be noted that whether or not a practitioner has timely paid his or her taxes is irrelevant to a proceeding predicated on a failure to timely file returns.80 A total of five separate (although not necessarily consecutive) years of failing to file personal tax returns in a timely manner seems to be OPR’s trigger for seeking a disbarment. In almost every reported noncompliance case resulting in disbarment the practitioner either failed to file or failed to pay his or her tax obligation in a timely manner for five or more separate years.81

78 OPR v. Suits, Complaint No. 2008-13 (Default decision dated 7/1/09). 79 31 CFR §10.81. 80 See OPR v. Gonzales, Complaint No. 2007-28 (Decision on Motion for Summary Judgment dated 8/29/08). 81 See OPR v. Blum, Complaint No. 2006-24 (Default Decision dated 3/9/07); OPR v. Bujan, Complaint No. 2009-7 (Default

Decision dated 7/1/09); OPR v. Hillerman, Complaint No. 2009-30 (Default Decision dated 1/26/10); OPR v. Marcus, Complaint No. 2007-40 (Default Decision dated 11/26/07); OPR v. Marks, Complaint No. 2007-36 (Default Decision dated 10/15/07); OPR v. Pernell, Complaint No. 2010-13 (Default Decision dated 10/4/10); OPR v. Rafferty, Complaint No. 2009-11 (Default Decision dated 6/17/09); OPR v. Solovy, Complaint No. 2009-23, (Default Decision dated 7/14/09); OPR v. Moose, Complaint No. 2007-38 (Decision on Appeal dated 3/16/09); OPR v. Salisbury, Complaint No. 2009-24


Keeping current with tax filing and payment obligations is essential for any practitioner representing clients before the IRS. In addition to exposure to sanctions under Circular 230, some states will revoke a CPA or law license for failure to file or pay with respect to state tax obligations. It should be noted that multiple years of noncompliance do not always result in disbarment. Cases involving as much as seven years of noncompliance have resulted in suspensions. For example, enrolled agent June Gittleson was suspended for only 36 months for failing to file returns for seven years82 and attorney Charles Stewart received a suspension of 48 months for failing to file for six years (Stewart also failed to pay interest and penalties related to five of those years).83 Most disbarment cases involving noncompliance are not contested, and when they are the reasons offered in defense of the practitioner’s actions typically carry little weight with the ALJ or Chief Counsel. For example, Tim Kaskey, a CPA, failed to file personal tax returns for seven years, from 2001 through 2007. In his defense he cited “on-going medical problems,” despite the fact that during the same period he filed many tax returns on behalf of clients. The only evidence he produced regarding his medical problems was a single prescription. Both the ALJ and, upon appeal, Chief Counsel discounted Kaskey’s excuse for his noncompliance.84 Attorney Alex Llorente cited marital difficulties in response to allegations that he willfully failed to file tax returns for a five year period. Not only did the Office of Chief Counsel uphold the ALJ’s decision to impose sanctions, it actually increased the sanction to disbarment, despite the fact that OPR had only sought a suspension.85 Attorney Peter DeLiberty claimed that his diabetes was the cause of his inability to file. On appeal the Chief Counsel, who unfortunately for the appellant was also a diabetic, sympathized but posited that a bout of the disease severe enough to be the legitimate cause for multiple years of nonfiling would have killed the practitioner. Since the practitioner lived, he was disbarred.86 Jeff Parrack, a CPA from Fort Worth, Texas, was also disbarred in part for noncompliance with personal tax filing and payment obligations. Parrack’s website touts him as “specializing in IRS negotiations in wage and levy releases” and boasts that he “talks and works with the IRS . . . at least five times a day,” has “released wage levies in all 50 states,” and claims that “every wage levy release I have ever attempted, I have released!!!”87 On a marketing website Parrack ironically states “You can check my current licensing and see that I have had no complaints with the Texas State Board of Public Accountancy (TSBPA).”88 Despite this self-aggrandizement, the allegedly astute Mr. Parrack failed to file his own returns for 2008 and 2009. He did manage to file returns for 2004 through 2007, but they were inaccurate. He also failed to pay federal tax assessments for the years 2001, 2002, 2003, 2007, and 2008. As if this were not enough, Parrack failed to include his tax identification number on returns he prepared during the period from 1997 through 2003 and was alleged to have failed to exercise due diligence in the preparation of his

(Decision on Appeal dated 8/5/10). But see Hubbard v. United States, Civil Action No. 07-0023 (D.D.C. 2008) (practitioner disbarred for failing to file for four years).

82 OPR v. Gittleson, Complaint No. 2008-15 (Default Decision dated 8/19/08). 83 OPR v. Steart, Complaint No. 2008-10 (Default Decision dated 8/19/08). 84 OPR v. Kaskey, Complaint No. 2009-26 (Decision on Appeal dated 5/28/10). 85 OPR v. Llorente, Complaint No. 2008-03 (decision on appeal, Apr. 10, 2009). 86 OPR v. DeLiberty, Complaint No. 2007-08 (Appeal Decision dated 7/08). 87 www.irslevyreleasepackage.com and www.taxnegotiations.com. 88 Accounting Software 4 Sale Directory at www.accountingsoftware4sale.com.

http://www.irslevyreleasepackage.com/


clients’ returns. Although he claimed great success against the IRS on behalf of his clients, alas poor Parrack did not bother to present a defense to these charges and was disbarred by consent.89

C. Disbarment Involving Incompetence Although a willful failure to file or pay federal tax obligations is among the transgressions described in Circular 230 as constituting “incompetence and disreputable conduct,”90 disbarments often involve other conduct as well. In the case involving CPA Tim Kaskey, during the course of an audit of one of his corporate clients it was found that the officer compensation reported on the corporate return did not match the wages reported on the corresponding individual returns of the officers, even though all the officers of the corporation were Kaskey’s clients. Furthermore, the corporate books clearly identified personal items of the individual officers that were being paid by the corporation with no loans or distributions being shown on the returns. Kaskey claimed that his clients had misrepresented their income to him, a claim that the Office of Chief Counsel concluded lacked any merit.91 As a result, Kaskey was found to have failed to determine the correctness of representations he made to the IRS during the audits and failing to inform his clients of the penalties reasonably likely to apply to them, as well as the opportunities to avoid such penalties. These actions, as well as the continuous failure to meet his own filing obligations for an extended period of time were deemed to be incompetent or disreputable conduct warranting disbarment.92 There is a somewhat troubling observation made by the Chief Counsel in the appellate decision regarding the Kaskey case. The Chief Counsel commented that it was “inconceivable” that the officers could pay their living expenses based on the income reported on their returns. Does this imply that practitioners are expected to determine whether clients could sustain their living expenses based on the reported income as part of the standard due diligence requirement? The Kaskey decision was based on a variety of factors and there is insufficient information to determine how “obvious” was the expanse between the reported income and the taxpayers’ lifestyles. Nonetheless, practitioners should be on notice that an observable disconnect between reported income and known lifestyle may give rise to an obligation for further inquiry. In a press release regarding the Kaskey case, OPR Director Karen Hopkins stated that, “Practitioners who think OPR isn’t serious about due diligence should take heed,” and “may not ignore the implications of information already known.” The OPR Director also observed that “This is yet another decision highlighting that practitioners have a duty to the system as well as to their clients. Practitioners who do not take this duty seriously can expect to be held accountable.” 93 Treasury regulations provide that the “tax return preparer generally may rely in good faith without verification upon information furnished by the taxpayer” and that the preparer “is not required to audit, examine or review books and records, business operations, documents, or other evidence to verify independently information provided by the taxpayer.”94 However, a tax preparer cannot wear blinders or

89 IRS Announcement 2011-4; 2011-4 IRB 424. 90 31 CFR §10.51(a)(6). 91 Id. 92 Id. 93 IR-2010-82, July 6, 2010. 94 Treas. Reg. § 1.6694-1(e)(1); 31 CFR §10.34.


hide his or her head in the sand. Facts that should be obvious to the preparer cannot be ignored and there is an affirmative obligation to make reasonable inquiries if the information supplied to the preparer appears, on its face, to be incorrect, inconsistent, or incomplete. It is always a good idea to obtain written representations from the taxpayer.

D. Disbarment Based on Criminal Convictions Interestingly, there were no decisions prior to the 2010 Everett case in which a practitioner was disbarred solely on the basis of a criminal conviction.95 In persuading the ALJ that disbarment was appropriate for Everett, OPR pointed to the multiple decisions in which practitioners were disbarred for failure to file federal tax returns, arguing that Everett’s convictions and the loss of his law license were far more serious and egregious than the failure to file federal tax returns. The ALJ noted that, in determining which sanction is appropriate, Circular 230 Section 10.50 provides only that “[t]he sanctions imposed ... shall take into account all relevant facts and circumstances.” As noted above, Circular 230 provides no guidance as to when disbarment or any other sanction is appropriate. Consequently, the ALJ decided to look to the American Bar Association (“ABA”) Standards for Imposing Lawyer Sanctions. The ABA standards indicate that disbarment is the appropriate sanction when a lawyer: (i) engages in serious criminal conduct a necessary element of which includes intentional interference with the administration of justice, false swearing, misrepresentation, fraud, extortion, misappropriation, or theft; or the sale, distribution or importation of controlled substances; or the intentional killing of another; or an attempt or conspiracy or solicitation of another to commit any of these offenses; or (ii) engages in any other intentional conduct involving dishonesty, fraud, deceit, or misrepresentation that seriously adversely reflects on the lawyer’s fitness to practice. On the other hand, if the lawyer engages in criminal conduct that seriously adversely reflects on the lawyer’s “fitness to practice” but does not contain the elements listed above, suspension is the appropriate sanction. The ABA Standards go on to list a series of aggravating and mitigating factors that should be considered. The ALJ concluded that Everett’s actions, as indicated by his conviction, reflected “serious criminal conduct a necessary element of which includes intentional interference with the administration of justice, false swearing, misrepresentation, [or] fraud,” or “intentional conduct involving dishonesty, fraud, deceit, or misrepresentation that seriously adversely reflects on the lawyer’s fitness to practice,” which suggests that the proper sanction is disbarment. Furthermore, the ALJ noted that Everett’s conduct also reflected aggravating factors of dishonest or selfish motive, and multiple offenses. Therefore, the ALJ determined that Everett’s criminal convictions and subsequent disbarment from the practice of law in two states warranted his disbarment from practice before the IRS, which is commensurate with the seriousness of his disreputable conduct. The ALJ noted that this conclusion was supported by Everett’s failure to file a response to OPR’s motion, in which he could have offered evidence of any mitigating circumstances or could have raised a genuine issue of fact material to what sanction was appropriate. It is difficult to predict when disbarment will be sought as a sanction by OPR. For example, in 2008 James Napolitano, a 55-year old CPA from Long Island, was representing a taxpayer with respect to a contested

95 OPR v. Everett, Complaint No. 2009-27 (Decision dated 7/22/10).


assessment. Apparently the client was not happy with the progress being made until Napolitano presented his him with a letter from the IRS indicating that the situation had been resolved in the client’s favor. Unfortunately, Napolitano had forged the letter and used what looked like IRS letterhead in an effort to trick the client. Because the matter had not, in fact, been resolved, Napolitano’s falsification eventually came to light. On April 10, 2008 Napolitano was arrested by local authorities and a U.S. Treasury agent and charged with forgery in the second degree and criminal possession of a forged instrument in the second degree. Two months later OPR filed a Complaint. Perhaps because Napolitano had not yet been convicted, the Complaint did not seek disbarment, but rather a suspension of 48 months, which was granted.96

IX. What Kinds of Cases Result in Suspensions?

A. Suspension for Failure to File As noted above, the failure to file personal income tax returns for five or more years often results in a disbarment. When disbarment is not sought for a failure to file for five years, suspension for three to four years is commonly the result.97 Lesser suspensions may be imposed for failing to file for three of four years,98 and suspensions may even be imposed for merely filing late returns.99 Excuses involving medical or marital problems are typically ineffective as a defense to a change of failure to file, particularly if the accused practitioner has continued to prepare and file returns for clients during the relevant period. For example, enrolled agent Juanita Gonzales claimed that an emotional disability and other personal problems prevented her from filing her tax returns.100 In support of this assertion, she submitted a statement from a therapist indicating that she “did not have the emotional reserves to file her own taxes in a timely manner.” In rejecting this defense, the Chief Counsel noted that Gonzales refused to present the therapist as a witness for cross-examination and continued to prepare and file returns for clients during the period of treatment.101 Practitioners should note that the obligation to file an income tax return is independent of any tax liability. Assuming the income threshold is met, every U.S. citizen is required to file a federal income tax return by statute, whether or not any tax payment is due.102 Because the penalties for not filing are based on the amount due, it is true that there may be no tax penalty for nonfiling in a particular case. Circular 230, however, requires that practitioners follow the law, not just that they avoid the imposition of tax penalties.

96 OPR v. Napolitano, Complaint No. 2008-14 (Default Decision dated 9/28/08). 97 See OPR v. Andrews, Complaint No. 2006-2 (Final Disposition dated 5/8/06); OPR v. Bidwell, Complaint No. 2009-2

(Final Disposition dated 8/17/09); OPR v. Dobkin, Complaint No. 2006-30 (Final Disposition dated 4/4/07); OPR v. Kilduff, Complaint No. 2008-12 (Decision on Appeal dated 1/20/10).

98 See OPR v. McDaniels, Complaint No. 2009-19 (Final Disposition dated 12/31/09) (failure to file for three years resulting in a suspension of 24 months); OPR v. Sutton, Complaint No. 2008-9 (Final Disposition dated 6/30/09) (failure to file for four years resulting in a suspension of 24 months); OPR v. Ohendalski, Complaint No. 2007-10 (Decision on Appeal dated 6/08) (failure to file for four years resulting in a suspension of 48 months).

99 OPR v. Ellis, Complaint No. 2008-2 (Final Disposition dated 7/14/08); OPR v. Guthrie, Complaint No. 2007-20 (Motion for Summary Judgment dated 5/9/08); OPR v. Hurwitz, Complaint No. 2007-12 (Decision on Appeal dated 4/28/09).

100 OPR v. Gonzales, Complaint No. 2007-28 (Decision on Appeal dated 12/9/09). 101 Id. 102 26 U.S.C. § 6012(a)(1)(A); Treas. Regs. § 1.6012-1(a)(1).


An interesting case regarding this point involved Daniel Yoder, an enrolled agent from Michigan. Yoder claimed a religious exemption from the payment of self-employment tax. In addition, the exemptions to which he was entitled eliminated any income tax liability so that it was undisputed that Yoder had no tax liability, and for that reason, he did not file his returns for four years. In imposing a suspension of two years for failure to file, the ALJ noted that “the requirement to file a return is based upon gross income levels, not taxability of the income.” Yoder’s claim to a religious exemption from self-employment taxes and the other factors eliminating his income tax liability, therefore, were irrelevant to the issue of whether or not he had to file.103

B. Suspension for Misrepresentation Enrolled agent Kevin Francis was suspended for two and a half years in 2006, primarily for his conduct representing clients in controversy matters. With respect to an employment tax investigation of a corporate client, Francis failed to supply documents requested and repeatedly changed his story with respect to such document requests, first saying he had provided them, then making promises to provide them at a later date, then blaming the delay on his clients, and finally stating that the documents did not exist. Francis eventually even alleged that the Revenue Officer had “a history of misfiling or losing documents.”104 Similar results ensued after Francis insisted that the case be transferred to another Revenue Officer. He refused to provide a Form 433-B to the second Revenue Officer, again providing multiple inconsistent reasons for his failure and blaming the Revenue Officer for not being clear as to what information was being requested. He also again blamed his client for not providing the information.105 In a case involving an individual taxpayer, Francis attempted to get a Notice of Federal Tax Lien released by calling IRS group, territory, and area managers and telling them, variously, that he had not been informed about the lien and that a subordination of the lien had already been agreed to. Both claims were verifiably false. Francis is reported to have become angry and made several false statements to the area manager, among them that he was not aware of the trust fund recovery penalty assessment, that he was not advised that the lien would be filed and that he had not had a conversation with the Revenue Officer when in fact he had.106 With respect to yet another case, Francis falsely maintained in a conversation with an IRS manager that other IRS personnel had agreed to a lien subordination. He later requested a withdraw of a CAP appeal of the subordination denial on the basis that the Taxpayer Advocate Office had upheld his position as to an allocation of payments and approved the subordination of the lien. The Taxpayer Advocate Office, in fact, never approved the subordination. In the words of the Chief Counsel: “The evidence is clear that when Francis did not get his way, he began making false assertions that the subordination had been agreed to in an attempt to bully the IRS officials into approving it.”107 Francis argued that he should not be sanctioned for an occasional late, or lack of, response. The problem, according to the Chief Counsel, was that the instances of failure to provide information were not occasional. “In every case there were multiple instances, a course of conduct that resulted at the very

103 OPR v. Yoder, Complaint No. 2007-33 (Decision dated 5/19/08). It should be noted that OPR sought disbarment in the

Yoder case, but the ALJ felt that a two year suspension was more appropriate. 104 OPR v. Francis, Complaint No. 2004-9 (Decision on Appeal dated 2/4/08). 105 Id. 106 Id. 107 Id.


least in delay in the resolution of the case, not to mention the waste of the IRS employees’ time and efforts.” Due to Francis’s pattern of behavior, he was sanctioned for neglecting or refusing to promptly submit records or information in a matter before the IRS on proper and lawful request, failing to exercise of due diligence in preparing and filing returns, documents and other papers relating to IRS matters and in determining the corrections of oral or written representations made to the Treasury Department, unreasonably delaying the prompt disposition of matters before the IRS, and engaging in disreputable conduct by knowingly giving false or misleading information to the IRS.108

C. Sanctions Imposed for Anger Management Issues Practitioners use a variety of approaches in dealing with the IRS. Some prefer to maintain a cordial, polite relationship and some are more adversarial in nature. Regardless of approach, practitioners are expected to zealously represent their clients, but sometimes the line between zealousness and abusive behavior is crossed. Practitioners are well advised to be careful in their choice of words, as Circular 230 includes the use of threats, false accusations, duress or coercion to influence an IRS employee among the actions considered incompetence and disreputable conduct for which a practitioner may be sanctioned.109 It would be fair to say that the approach used by Milton Friedman, a Florida CPA, falls more toward the aggressive end of the spectrum. During a meeting with IRS employees in 2001, Friedman stated that he had reported an IRS group manager to Inspection, referred to her as “an a*****e,” and said that that he was going to “turn her around 180 degrees.” He referred to another IRS employee as “stupid.”110 In 2002, when an IRS manager called Friedman in response to information requested by the CPA, Friedman is reported to have stated: “You arrogant, sarcastic a*****e” and hung up. In a subsequent letter to OPR defending his actions, Friedman observed that the manager was, in fact, arrogant and sarcastic, but offered no proof that he was an a*****e.111 In 2003, after receiving several additional complaints from IRS personnel that Friedman had used offensive, threatening, and insulting language with them, OPR contacted Friedman and suggested he consent to a public censure for his conduct.112 During the negotiations with OPR Friedman suffered a heart attack. Presumably mellowed by that ordeal, Friedman consented to a public censure on December 30, 2003, in which he agreed, among other things, to avoid the “use of terminology or statements that could be construed as offensive, threatening, or insulting” for a period of three years.113 While the heart attack may have mellowed Milton, it did not emasculate him. Seven months after he consented to the censure he once again became entangled in a less than civil relationship with a Revenue Officer. After sending several complaints to the Revenue Officer and her manager regarding what Friedman considered to be unwarranted collection activity, he made a demand to meet with District Counsel regarding the matter. When the Revenue Officer failed to set up a meeting between Friedman and District

108 Id. 109 31 CFR § 10.51(a)(9). 110 OPR v. Friedman, Complaint No. 2005-15 (Decision on Appeal dated 4/2008). 111 Id. 112 Id. 113 Id.


Counsel, the CPA sent the Revenue Officer a certified letter demanding she withdraw a Notice of Levy and stating, “I am putting you on notice that any damages incurred, in the interim, will be the basis for a suit brought against you personally, as well as your employer.”114 OPR found that this letter violated Friedman’s censure agreement. There is a significant difference, OPR felt, between filing a complaint about an IRS employee’s allegedly improper actions and telling the employee that, if he or she does not do what is requested, then a complaint will be made or a lawsuit will be commenced. The former is a statement of fact, according to OPR, while the latter could be construed as a threat. Friedman, of course, had agreed to refrain from making threats.115 In the decision imposing a suspension on Friedman, the ALJ concluded that Friedman’s language constituted threats and attempts to interfere with and influence IRS employees in the exercise of their official duties. “The threat of being subjected to a lawsuit,” the ALJ observed, “no matter how frivolous, is a matter of concern to anyone.” Friedman was suspended for one year for violating his censure agreement.116 The Friedman case should not inhibit practitioners from zealously representing their clients or from raising legitimate concerns about the conduct of IRS employees. The proper response to such concerns, however, should be the lodging of a complaint or taking other appropriate actions. In Friedman it was the practitioner’s threats to take action that were clearly being utilized in an effort to influence the IRS that caused the problem.

X. Conduct That Does Not Violate Circular 230 When OPR files a Complaint against a practitioner seeking sanctions, they almost always win. Not only does OPR almost always win the case in chief, the vast majority of ALJ decisions impose the specific sanction sought. As detailed above, an appeal might even result in an increased sanction. In a few rare instances, however, the practitioner has been vindicated in a disciplinary hearing.

A. Valid Excuses for Nonpayment Nonpayment of federal income tax assessments is not a per se violation of Circular 230. As with nonfiling, it is only an action that is willful that results in sanctions. As seen in the cases discussed above, willfulness is not a difficult standard for OPR to meet when it comes to a practitioner’s failure to file. By definition, practitioners are well versed in filing requirements, and absent some physical inability to do so, it is hard for a practitioner to construct a successful argument that his or her failure to meet a filing obligation was anything other than willful. Payment, however, is another matter. It is not hard to imagine how financial circumstances could stand in the way of meeting a payment obligation, even by the most astute practitioner. For example, CPA Edwin Davis was charged with failure to pay his tax liabilities in a timely manner over a multiple year period. During the period in question, Davis earned an annual average of only slightly more than $20,000 from his accounting practice. In fact, he had even considered abandoning his practice to pursue a career as a screenwriter. He had no savings and three minor children to support. His financial

114 Id. 115 Id. 116 Id.


situation caused him to be delinquent in his child support obligations. While the ALJ did not see any of these facts as mitigating the charge of failure to pay, on appeal the Office of Chief Counsel determined that the facts indicated the payment failures were not “voluntary” and “willful” and thus did not constitute disreputable conduct.117

B. Disclosure in Collection Cases As all practitioners involved in collection matters know, there is an inherent tension between candid disclosure of a client’s financial condition and client confidentiality. The tension was the root of a charge of disreputable conduct levied against California attorney Philip Panitz in 2006. When submitting offers-in-compromise to the IRS, Panitz’s practice is to have his client pay into his attorney trust account the amount of the offer in advance so the money will not be dissipated by the time the offer is “worked.” With regard to one particular offer submitted by Panitz, an associate failed to follow his usual practice of notifying the IRS in a cover letter that the offer funds were being held in the trust account. In a statement attached to the offer forms, however, it was noted that “the funds necessary to make this offer” remained as an asset of the taxpayers.118 When the IRS requested a copy of his “retainer/fee agreement . . . establishing the terms of payment, an accounting of the payments made to date, and a statement of the current balance due,” the same associate replied that, “Money paid to an attorney has been held [to be] information between an Attorney and Client, and since the money has been spent it is somewhat irrelevant anyway to an offer in compromise calculation.” Subsequently, Panitz’s office did notify the IRS that the money to be used for the offer had been deposited into his attorney trust account.119 It is clear that an attorney submitting an offer-in-compromise has an obligation to notify the IRS about client assets held in his or her attorney’s trust account. While the ALJ agreed with OPR that Panitz’s communication to the IRS in this regard was not “entirely forthcoming,” she also noted that nothing about the communication was false or misleading, and therefore no sanction could be imposed.120 In another instance, Panitz had his clients pay into his trust account an amount designated to pay a state tax liability. This amount was not disclosed to the IRS when an offer-in-compromise related to the client’s federal tax liability was submitted. When the IRS later requested a complete disclosure of all funds the firm held on the client’s behalf, Panitz provided documentation of the entire amount deposited into his trust account, which included the amount designated to fund the state tax liability.121 With regard to this instance the ALJ focused on the “willful” nature of the omission, observing that “the evidence further shows that [the IRS] often had to ‘flesh out’ the information provided in taxpayers’ offers-in-compromise, from which it is reasonable to infer that it is not uncommon for taxpayers to omit or fail to disclose pertinent information in their offers without, presumably, incurring the penalties described in Circular 230.” On this basis the ALJ determined that “It follows, and I find, that willfulness cannot be established by mere omission or failure to disclose information but must be evidenced by conduct from

117 OPR v. Davis, Complaint No. 2007-35 (Decision on Appeal dated 3/10/09). Note that Davis was, in fact, disbarred for

concurrent charges of failure to file his personal income tax and employment returns. 118 OPR v. Panitz, Complaint No. 2006-25 (Decision dated 6/15/09). 119 Id. 120 Id. 121 Id.


which an intent to deceive or mislead may be inferred. Thus, nondisclosure alone cannot prove a ‘knowing’ submission of false or misleading information.”

C. Being Wrong in a Written Opinion In another 2006 case, OPR alleged that attorney John Sykes failed to exercise due diligence and willfully engaged in disreputable conduct in connection with certain opinions he issued to an investment firm.122 The opinions in question dealt with a series of leasing transactions. Specifically, they addressed the basis, for tax purposes, of certain preferred stock held by an offshore entity as a result of an exchange transaction. Some of that stock was acquired by the investment firm which requested tax opinions as to the basis of the stock in order to claim substantial losses on its partnership tax returns when the stock was sold and to insulate it from penalties that might be asserted by the IRS.123 The opinions authored by Sykes opined that: (i) the exchange transactions met the requirements for a tax-free exchange under §351 of the Code; (ii) the stock received by the offshore entity would have a basis equal to the amount specified therein; and (iii) if the offshore entity were to sell that stock for cash in a bona fide arms-length transaction with economic substance, its gain or loss from that sale would be determined by reference to the basis specified in the opinion.124 Subsequently, the investment firm sold the stock and claimed a loss on its tax returns based on the Sykes opinion. Upon examination that loss was disallowed by the IRS on the basis that the transactions were sham transactions lacking any non-tax business purpose and that there was no reasonable expectation of profit apart from the benefits accruing to the investment firm from the purported losses for tax purposes. Substantial tax penalties were also imposed on the investment firm. The investment firm challenged the IRS ruling in federal court and lost.125 In filing its Complaint against Sykes, OPR asserted that Sykes’ use of short form opinions, which contained “facts, assumptions and conclusions without setting forth any analysis,” put the investment firm at risk because they did not show that all relevant information had been taken into account and they did not provide adequate documentation to justify the tax position or provide it with penalty protection.126 The ALJ, however, found that it was accepted practice to issue short form opinions that did not contain the full legal analysis of the practitioner issuing the opinion. Sykes did perform that analysis, according to the ALJ, and the fact that it was not detailed in the opinion letter did not equate to a lack of due diligence.127 More importantly, implicit in the decision is that having been determined to be incorrect in the analysis of a complex tax matter does not constitute disreputable conduct. As long as they are careful, tax practitioners can be wrong without having to suffer a sanction.

XI. New Written Advice Standards A practitioner giving written advice (including by means of electronic communication) concerning one or more federal tax matters is subject to the requirements in section 10.37 of Circular 230. A “federal tax matter” means: (1) any matter concerning the application or interpretation of a revenue provision of the 122 OPR v. Sykes, Complaint No. 2006-1 (Decision dated 1/29/09). 123 Id. 124 Id. 125 Id. 126 Id. 127 Id.


Internal Revenue Code; (2) any provision of law impacting a person’s obligations under the internal revenue laws and regulations, including but not limited to the person’s liability to pay tax or obligation to file returns; or (3) any other law or regulation administered by the IRS. Government submissions on matters of general policy are not considered written advice on a federal tax matter for this purpose. Furthermore, continuing education presentations provided to an audience solely for the purpose of enhancing practitioners’ professional knowledge on federal tax matters are not considered written advice on a federal tax matter. However, presentations marketing or promoting transactions generally will be considered the giving of tax advice. When providing written tax advice, the practitioner must comply with six standards. First, he or she must base the written advice on reasonable factual and legal assumptions, including assumptions as to future events. This means that the practitioner cannot rely on speculative hypothetical situations, but must ascertain the facts with reasonable acuity. Second, the practitioner must reasonably consider all relevant facts and circumstances that the practitioner knows or reasonably should know. Third, the practitioner use reasonable efforts to identify and ascertain the facts relevant to written advice on each federal tax matter. Fourth, the practitioner may not rely upon representations, statements, findings, or agreements (including projections, financial forecasts, or appraisals) of the taxpayer or any other person if reliance on them would be unreasonable. Such reliance would be unreasonable, for instance, if the source of the information was known to be incompetent or biased. Reliance on representations, statements, findings, or agreements is unreasonable if the practitioner knows or reasonably should know that one or more representations or assumptions on which any representation is based are incorrect, incomplete, or inconsistent. A practitioner may only rely on the advice of another person if the advice was reasonable and the reliance is in good faith considering all the facts and circumstances. Reliance is not reasonable when the practitioner knows or reasonably should know that the opinion of the other person should not be relied on, when the practitioner knows or reasonably should know that the other person is not competent or lacks the necessary qualifications to provide the advice, and when the practitioner knows or reasonably should know that the other person has a conflict of interest. Fifth, the practitioner must relate applicable law and authorities to facts. The sixth standard is really a prohibition. Specifically, a practitioner may not, in evaluating a federal tax matter, take into account the possibility that a tax return will not be audited or that a matter will not be raised on audit. In evaluating whether a practitioner giving written advice concerning one or more federal tax matters complied with these requirements, the IRS will apply a “reasonable practitioner” standard, considering all facts and circumstances, including, but not limited to, the scope of the engagement and the type and specificity of the advice sought by the client. This makes it crucial that the practitioner have a clear, documented understanding with the client as to the scope of the engagement. In the case of an opinion the practitioner knows or has reason to know will be used or referred to by a person other than the practitioner (or a person who is a member of, associated with, or employed by the practitioner’s firm) in promoting, marketing, or recommending to one or more taxpayers a partnership or other entity, investment plan or arrangement a significant purpose of which is the avoidance or evasion of any tax imposed by the Internal Revenue Code, the IRS will apply a reasonable practitioner standard,


considering all facts and circumstances, with emphasis given to the additional risk caused by the practitioner’s lack of knowledge of the taxpayer’s particular circumstances, when determining whether a practitioner has failed to comply with these requirements.

Ethical Considerations for CPAs · 2017-06-27 · immutable – they are founded on unchanging...

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Transcript of Ethical Considerations for CPAs · 2017-06-27 · immutable – they are founded on unchanging...