Ethics and due diligence for the tax professional
Due diligence means knowing the relevant facts. It’s knowing the relevant tax law and matching the facts to the law.
The due diligence requirements have been expanded to include the Earned Income Credit, the Child Tax Credit, and the Additional Child Tax Credit, as well as the American Opportunity Tax Credit, the Other Dependent Credit, and the Head of Household filing status.
To meet the due diligence requirements, tax professionals must complete Form 8867, Paid Preparer’s Due Diligence Checklist, and submit it with the e‐filed or paper‐filed tax return. In addition, any applicable worksheets must be completed and retained. Most professional tax software includes worksheets, but you cannot rely on your software to answer all the questions. Copies of Form 8867, as well as all worksheets used to claim the EITC, CTC, AOTC, or Head of Household filing status on the tax return, must be retained.
In addition, other information that must be retained includes any documents relied on to complete the tax return and Form 8867, a record of how, when, and from whom the information to complete the return was obtained, as well as a record of any additional questions asked to determine the eligibility of any credits and the correct filing status, and the answers to those questions.
Records must be kept for at least three (3) years from the latest of the due date of the return, or the date the return was e‐filed. If the return was paper filed, it is from the date the taxpayer received the return.
Tax practitioners are required to exercise due diligence when submitting documents to the IRS. Practitioners can rely on third-party documents, unless there is reason to believe that those are not accurate. Tax professionals, however, cannot ignore facts and are required to make reasonable inquiries if the information presented appears to be incorrect, incomplete, or inconsistent.
If a practitioner is aware that a client has not complied with tax laws, or has made an error on any return that has already been submitted to the IRS, then he or she has to promptly advise the client of the noncompliance, error, or omission, as well as the consequences of not correcting the error or omission.
Even though section 10.21 of Circular 230 does not require the practitioner to amend an inaccurate return, the practitioner must make sure that any error is not continued on any subsequent returns that he or she is preparing. For example, if the taxpayer incorrectly calculated a capital loss and has a carryover, the carryover amount needs to be recalculated to the correct carryover amount, before the preparer can sign the return.
Generally, a tax practitioner is prohibited from representing a client if a conflict of interest exists.
A conflict of interest may exist when the representation of one client adversely affects another client, or when the representation of one client is materially limited by the practitioner’s responsibilities to another client or a personal interest.
If a conflict exists, the tax practitioner may represent the client with consent, but only if he or she reasonably believes that he or she will be able to provide competent representation to each client, the representation is not prohibited by law, and each affected client waives the conflict of interest in writing. Copies of the consent must be retained for at least 36 months after the conclusion of the representation.
One common situation where a conflict of interest may arise is in partnerships, when giving tax advice to one partner with regards to the partnership may adversely affect the other partner. Deciding what type of depreciation to take may benefit one partner, but not the other.
Divorces always create a conflict of interest. Giving tax advice to one spouse may adversely affect the other spouse, especially when it pertains to retirement distributions and property settlements.
Tax practitioners need to watch out for innocent and injured spouse issues. There might be omitted income from sources the taxpayer does not want the spouse to know of. This might be a situation to file married filing separately.
Audits are another example of a potential conflict of interest. A tax practitioner who prepared the return that is under audit might be worried about preparer penalties, and might be less supportive of the client. The practitioner can only proceed with the audit engagement if he or she believes that they can work in the clients’ best interest, the practitioner is not legally prohibited from continuing the engagement, and each person is notified in writing of the conflict of interest and consents to the engagement.