I

2016 TaxEase, LLC

2-HOUR CONTINUING EDUCATION

2 HOUR CTEC APPROVED COURSE NUMBER - 3064-CE-0041

2 HOUR ETHICS – IRS COURSE NUMBER: B8FQK-E-00017-16-S

PHONE NUMBER: 877-829-2667 WEBSITE: www.taxeaseed.com

II

Objectives

TaxEase objective is to:

Provide continuing education for seasoned tax preparers

Provide the student with comprehensive learning material, including examples and

interactive questions and answers to assist in the learning process.

Give an update and review of current tax matters.

Supply material that will give a wealth of information for use as a reference.

Meet all the requirements for a CTEC registered tax preparer

Meet all IRS voluntary continuing education requirements to receive an IRS Record of

Completion.

Specific objectives are stated at the beginning of each chapter.

The authors of this publication are offering a continuing education program only. TaxEase LLC

and the authors are not rendering any legal, accounting or other professional advice whatsoever.

There is always the possibility of error in every publication, though we try to avoid it. If a

significant error comes to our attention, you will find a correction on our website

www.taxeaseed.com. Your own research is always recommended. All tax situations and facts

differ. We strongly recommend that you do additional research and refer to IRS code and

publications in all situations. We do not take responsibility for any professional advice given to

you or given by you to others.

Laws change frequently; please make certain to update any information given herein with the

IRS and our website.

Tax preparers can use this course to meet their 15-hour federal continuing education

requirement. TaxEase is required to report continuing education hours that a student successfully

completes to the IRS if a valid PTIN is provided on TaxEase Personal Information Form (paper

exam) or the User Information screen (online exams).

This Continuing Education class is a CTEC-approved course, which fulfills the 20-hour

“continuing education” requirements for tax preparers in California. A listing of additional

requirements to register as a CTEC tax preparer can be obtained by contacting CTEC at P.O.

Box 2890, Sacramento, CA, 95812-2890, by phone at (877) 850-2832, or on the Internet at

www.ctec.org. TaxEase, LLC is an approved education provider.

III

2015 Tax Year

This text will be continually updated to put in the 2016 tax law changes as they become

effective. The references made to 2015 are for examples where information for 2016 is not

available.

An update page will be available on our website (www.taxeaseed.com) for students to stay

abreast of the latest tax law changes. All required changes announced by CTEC will be sent to

students who previously purchased this course.

Assignments

This is an intermediate course, designed for seasoned tax preparers, who have the basic

knowledge of tax law. This course references the Internal Revenue Code, tax publications and

tax case law. TaxEase recommends that you use IRS publications available on the IRS website

for additional information, though they are not needed to complete this course.

The student is required to thoroughly read this syllabus. All courses include review questions

which we call “What Do You Think” to help guide the student. This course contains all answers

to the final exam questions.

To receive Internal Revenue publications, forms or instructions call or visit their website:

IRS: (800) 829-3676 www.irs.gov

CTEC: (877) 850-2832 www.ctec.org

CTEC rules require all students to renew their CTEC registration by October 31, 2016 (CTEC

allows late registration between Nov. 1, 2016 and Jan 15, 2017).

All continuing education must be paid for in advance. We offer a full money back guarantee, if

requested within thirty (30) days of date ordered and prior to submission of any answer sheet for

grading. TaxEase will not exchange any courses for the following year.

IV

Certification and Instructions

1. The Final Exam Questions, Final Exam Answer Sheet, Personal Information Form and

Evaluation Sheet are found at the back of this text. The exam is open book; all the answers

are included in the text.

2. There is only one correct answer per question. Mark an “X” in the correct answer box on the

Final Exam Answer Sheet provided. All questions in all sections of the Final Exam must be

completed before submitting the answer sheet to TaxEase. Only TaxEase answer sheet will

be accepted.

3. Email or fax the following items: Answer Sheet, Personal Information Form, Course

Evaluation.

Fax: 510-779-5251

Scan and email: support@taxeaseed.com

4. TaxEase will grade the final exam. A score of 70% or better in each part is passing. Submit

ONLY the Answer Sheet, Personal Information Form and Evaluation Page.

5. If you do not pass the test the first time, you may retake the test within 30 days at no

additional charge.

6. Paper certificates are available instead of email certificates for $12 each. Paper certificates

are ordered on the Personal Information Form at the time the exam is submitted.

7. Students must provide TaxEase with their current CTEC number. No tests will be graded

unless the CTEC number is on the TaxEase Personal Information Form. If your registration

is not current with CTEC, do not complete this course for CTEC continuing education.

TaxEase will report your continuing education hours to CTEC within 10 days of successful

passage of this course.

8. TaxEase will report 15 hours of continuing education to your PTIN account upon successful

passage of this course if a valid PTIN is entered on TaxEase Personal Information Form.

TaxEase reports continuing education to the IRS within the required timeframes.

V

Contents

Objectives .......................................................................................................................................... II 2015 Tax Year .................................................................................................................................... III

Assignments ..................................................................................................................................... III Certification and Instructions ....................................................................................................... IV

Contents ................................................................................................................................................. V

2 HOUR ETHICS ............................................................................................................................ 1 Chapter One – Circular 230 ............................................................................................................... 1

Internal Revenue Code ................................................................................................................... 1

Circular 230 ............................................................................................................................................ 1

Annual Filing Season Program .................................................................................................... 2 Practical Examples .......................................................................................................................... 5

§ 10.21 Knowledge of Client’s Omission ................................................................................... 5

Due Diligence .................................................................................................................................... 6 Fees ..................................................................................................................................................... 8

Conflict of Interest ........................................................................................................................... 9 What Do You Think? ....................................................................................................................... 12

What Do You Think? - Answers ................................................................................................... 13 Chapter Two - Statute of Limitations .............................................................................................. 14

Date Considered Filed .................................................................................................................... 14

Mailbox Rule ...................................................................................................................................... 14

Six-Year Statute for Certain Omissions from Gross Income ............................................... 16

What Do You Think? ....................................................................................................................... 18

What Do You Think? - Answers ................................................................................................... 19

Chapter Three - Disclosure, Document Protection and Rules ................................................ 20 Internal Revenue Code §7216 ....................................................................................................... 20 IRC § 7216 - Related to the Affordable Care Act ...................................................................... 21

Revenue Procedure 2013-14 ......................................................................................................... 22 Federally Authorized Tax Practitioner-Client Privilege ......................................................... 26

What Do You Think? ....................................................................................................................... 28 What Do You Think? – Answers .................................................................................................. 29

Chapter Four - Sanctions for the Violation of Regulations ...................................................... 30 Circular 230 §10.50 Sanctions ...................................................................................................... 30 Circular 230, Subchapter C §10.51- Incompetence and disreputable conduct. .............. 30

National Taxpayer Advocate – Report to Congress ............................................................... 31 Trade or Business Expenses Under IRC §162 and Related Sections ................................ 33

Damage Awards ............................................................................................................................... 36

What Do You Think? ....................................................................................................................... 38

What Do You Think? - Answers ................................................................................................... 39 Chapter Five - Identity Theft .............................................................................................................. 28

Efforts by the IRS ............................................................................................................................. 28

SCAMS ................................................................................................................................................ 30 Information for Tax Preparers ...................................................................................................... 33

Federal Trade Commission Publications .................................................................................. 33 Return Preparer Fraud .................................................................................................................... 34

VI

False Form 1099 Refund Claims .................................................................................................. 34

Hiding Income Offshore ................................................................................................................. 36

“Free Money” from the IRS & Tax Scams Involving Social Security ................................. 37 False/Inflated Income and Expenses .......................................................................................... 37

Frivolous Arguments ...................................................................................................................... 38 Falsely Claiming Zero Wages ....................................................................................................... 38

What Do You Think? ....................................................................................................................... 40 What Do You Think? - Answers ................................................................................................... 41 Final Exam - Ethics .......................................................................................................................... 1

Answer Sheet ........................................................................................................................................ 4 2016 Continuing Education Student Course Evaluation ....................................................... 6

2016

TaxEase, LLC

2 HOUR CONTINUING EDUCATION

20 HOUR CTEC APPROVED COURSE NUMBER 3064-CE-0041

2 HOUR ETHICS – IRS COURSE NUMBER: B8FQK-E-00017-16-S

MAILING ADDRESS: c/o POSTAL ANNEX, 39270 PASEO PADRE PKWY., #624, FREMONT, CA 94538

PHONE NUMBER: 877-829-2667 WEBSITE: www.taxeaseed.com

FAX NUMBER: 510 779-5251 EMAIL: support@taxeaseed.com

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Ethics

Chapter One – Circular 230

Internal Revenue Code

Congress writes the tax laws, which become part

of the Internal Revenue Code (IRC). The tax code

is amended every year.

Congress has given the IRS the power to interpret the tax code through a series of IRS

Regulations. These regulations are expanded versions of some tax code provisions with

illustrations of how the law is applied in different situations. The regulations are about four times

the length of the tax code itself. The IRS also publishes revenue rulings, revenue procedures, and

letter rulings, as well as publications and instructions, which provide guidance in much the same

manner as the regulations.

The IRS does not have the final say on interpreting the tax code. The federal court system

composed of the U.S. Tax Court, federal district courts, the U.S. Court of Federal Claims, and

U.S. Bankruptcy courts, all have the power to decide, on a case-by-case basis, how Congress

intends the tax laws to be applied. In addition, if more than $50,000 is at stake, a taxpayer can

appeal a tax court decision to a Circuit Court of Appeal and in rare cases to the U.S. Supreme

Court.

Our objective in this course is to provide practical examples and court case decisions, which will

show the practitioner a clear view of the ethics, discussed in these examples.

NOTE: Provisions of the CA Business and Profession Code referring to CA Registered Tax

Preparer are explained in the CA Section.

Circular 230

The Treasury Department Circular 230 (Revised 8-2011) is the Regulations Governing Practice

before the Internal Revenue Service. A copy of these new regulations can be found on the IRS

website.

Circular 230 is sometimes an incredibly complex document that addresses a broad range of

topics. Treasury and the IRS have consistently maintained that tax practitioners must meet

minimum standards of conduct and those who do not should be subject to disciplinary action,

including suspension or disbarment.

Objective

Understand the PTIN and AFSP

requirements for tax preparers

Understand the responsibility and

limitations of non-exempt tax preparers

Recognize the importance for the tax

preparer to use due diligence when

preparing a tax return.

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Ethics

PTIN

Beginning January 1, 2011, all paid preparers, regardless of their designation, must have a

Preparer Tax Identification Number (PTIN) before preparing returns. Tax Preparers can sign up

for their PTIN online or by paper application. Effective November 1, 2015 the fee is $50.1

The annual renewal cost is also $50 ($33 user fee and $17 third-party fee). Preparers will be able

to renew either online or on paper. All paid preparers must have a PTIN to prepare tax returns for

compensation. The PTIN does not give the preparer the right to represent taxpayers before the

IRS unless qualified by one of the designations below.

District Court Injunction

On Friday, Jan. 18, 2013, the United States District Court for the District of Columbia enjoined

the Internal Revenue Service from enforcing the regulatory requirements for registered tax return

preparers. In accordance with this order, tax return preparers covered by this program are not

required to complete competency testing or secure continuing education. The ruling does not

affect the regulatory practice requirements for CPAs, attorneys, enrolled agents, enrolled

retirement plan agents or enrolled actuaries.

The case which was brought in U.S. District Court for the District of Columbia (Loving et al,

2013-1 USTC §50156). This case can be found online at the Government Printing Office2.

Annual Filing Season Program

The voluntary Annual Filing Season Program is intended to recognize and encourage unenrolled

tax return preparers who voluntarily increase their knowledge and improve their filing season

competency through continuing education (CE). An unenrolled or unlicensed tax preparer may

represent a tax client only if they successfully complete the AFSP course, have an active PTIN

and consent to adhere to Circular 230 practice obligations.

How to Obtain an AFSP – Record of Completion

Successfully complete 18 hours of continuing education from IRS-Approved CE Providers,

including:

A six (6) hour Annual Federal Tax Refresher (AFTR) course that covers filing season

issues and tax law updates, as well as a knowledge-based comprehension test

administered at the end of the course by the CE Provider;

Ten (10) hours of other federal tax law topics; and

Two (2) hours of ethics.

Have an active preparer tax identification number (PTIN).

Consent to adhere to specific practice obligations outlined in Subpart B and section 10.51 of

Treasury Department Circular No. 230.

1 www.irs.gov/taxpros 2www.gpo.gov/fdsys/granule/USCOURTS-dcd-1_12-cv-00385/USCOURTS-dcd-1_12-cv-00385-1/content-

detail.html

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Ethics

Record of Completion

After PTIN renewal season begins in October, a Record of Completion will be generated once all

requirements have been met, including renewal of the PTIN for 2017 and consent to the Circular

230 obligations. A PTIN that is not renewed and fees are not paid for three consecutive years

will be dropped from the IRS PTIN database. Providers will no longer be able to enter CE credits

for that preparer.

The following are exempt return preparers who can obtain the AFTR – Record of Completion

without taking the AFTR course are:

Anyone who passed the Registered Tax Return Preparer test administered by the IRS

between November 2011 and January 2013

Established state-based return preparer program participants currently with testing

requirements: Return preparers who are active registrants of the Oregon Board of Tax

Practitioners, California Tax Education Council (CTEC), and/or Maryland State Board of

Individual Tax Preparers.

SEE Part I Test-Passers: Tax practitioners who have passed the Special Enrollment Exam

Part I within the past two years

VITA volunteers: Quality reviewers and instructors with active PTINs

Other accredited tax-focused credential-holders: The Accreditation Council for

Accountancy and Taxation’s Accredited Business Accountant/Advisor (ABA) and

Accredited Tax Preparer (ATP) programs

Exempt return preparers must also renew his or her preparer tax identification number (PTIN) for

the upcoming year and consent to adhere to the obligations in Circular 230, Subpart B and

section 10.517.

AFSP participants are included in a public database of return preparers on the IRS website. The

directory includes the credentials and qualifications of all qualified federal tax return providers.

UNLIMITED REPRESENTATION RIGHTS: Enrolled agents, certified public accountants,

and attorneys have unlimited representation rights before the IRS, this means they may represent

their clients on any matters including audits, payment/collection issues, and appeals.

Enrolled Agents – People with this credential are licensed by the IRS and specifically

trained in federal tax planning, preparation and representation. Enrolled agents hold the

most expansive license the IRS grants and must pass a suitability check, as well as a three-

part Special Enrollment Examination, a comprehensive exam that covers individual tax,

business tax and representation issues. An EA is required to complete 72 hours of

continuing education every 3 years. This must be done by obtaining a minimum of 16 hours

of continuing education (including 2 hours of ethics or professional conduct) each year. For

more information on enrolled agents, see Publication 4693-A, A Guide to the Enrolled

Agent Program.

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Ethics

Certified Public Accountants are credentialed individuals (unlike Enrolled Agents)

licensed by state boards of accountancy, the District of Columbia, and U.S. territories, and

have passed the Uniform CPA Examination. They also must meet education, experience,

and good character requirements established by their boards of accountancy. In addition,

CPAs must comply with ethical requirements as well as complete specified levels of

continuing education in order to maintain an active CPA license. CPAs can offer a range of

services; some CPAs specialize in tax preparation and planning.

Attorneys are individuals with credentials licensed by state courts or their designees, such

as the state bar. Generally, requirements include completion of a degree in law, passage of

an ethics and bar exam and on-going continuing education. Attorneys can offer a range of

services; some attorneys specialize in tax preparation and planning.

LIMITED REPRESENTATION RIGHTS: Preparers without any of the above credentials

have limited practice rights and may only represent clients whose returns they prepared and

signed only at the initial audit level. Under USC section 7701(a)(36), a tax return preparer is any

person who prepares for compensation, or employs others to prepare for compensation, all or a

substantial portion of any tax return or claim for refund under the IRC.

NOTE: Registered Tax Return Preparers – Certain preparers became RTRPs under an

IRS program that IRS is no longer able to enforce due to a District Court injunction. RTRPs

passed an IRS competency test based on Form 1040 tax preparation.

In April 2015, the Office of Professional Responsibility (OPR) issued Alert 2014-05 reminding

tax preparers that the Commissioner signed a delegation order that gives OPR the authority to

process referrals for misconduct by tax return preparers who engage in limited practice before

the IRS. OPR also has the authority to issue disciplinary actions in connection with the new

Annual Filing Season Program (AFSP).

Return Preparer Office Federal Tax Preparer Statistics as of April, 2016

The IRS mentioned that many PTIN holders, who completed their Annual Filing Season

Program Courses, did not complete their Record of Completion showing they met the

requirement to comply with Circular 230. Without the Record of Completion, the tax preparer

will not be able to represent clients even though they completed the course and the tax preparer’s

CE credits are in their PTIN account.

Number of Individuals with PTIN’s for 2016 707,229

Professional Credentials

Attorneys 29,666

Certified Public Accountants 210,641

Enrolled Actuaries 320

Enrolled Agents 51,341

Enrolled Retirement Plan Agents 703

Other Qualifications

AFSP Records of Completion 60,130

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Practical Examples

Practical Example 1: A first-time client comes into a tax preparer’s office for tax preparation.

He supplies the preparer with his W-2’S, 1099’s, Mortgage Interest Statement and a Brokers

Statement. The preparer verifies his prior year information on his 2014 tax return he supplied

and then begins to review his documents. While reviewing his documents the preparer notices

that the Brokers statement is from 2014 not 2015, furthermore there is a sale of stock and some

interest on this statement that was not reported in 2014.

The preparer discusses the omission with the client. He says that he opened the account in 2014

and noted he bought and sold some stock and had a gain on the sales of $2,500. The preparer

advises the client to amend the 2014 return as soon as possible. After further discussion, the

client decides he would rather wait for the IRS to contact him and he does not want to amend the

prior year return.

§ 10.21 Knowledge of Client’s Omission

The action taken in the above example is in accordance with §10.21 Knowledge of Client’s

Omission from Circular 230, it states that the preparer must advise the taxpayer immediately of

any error or omission discovered in a tax return. A discussion of the remedy, which in this case

would be amending the return and the interest and penalties that may occur should be completed

immediately. Amended returns are sometimes confusing to a taxpayer, it is important that the

taxpayer understands all income from all sources must be reported on a return and as a preparer

the best course of action is to amend the return.

It is the decision of the taxpayer how to proceed and not to amend this return and the preparer

must abide by that decision, even if he or she do not agree. Circular 230 does not require the

preparer to inform the IRS of the omission

NOTE: Although it is not required, if a taxpayer does not amend or correct an error or omission,

it is recommended that the preparer advises the client in writing and notations be made in the

file. In this example, it is the advice of the tax preparer that the 2014 tax return be amended

before completing the 2015 tax return. In this case, against the preparer’s advice the taxpayer did

not amend the return.

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Ethics

Due Diligence3

There is no exact set of standards a tax preparer must apply in preparing a tax return. When a tax

return is completed and ready for submission to the IRS, the taxpayer and the preparer sign a

declaration. The declaration for the preparer includes the following “Declaration of preparer

(other than taxpayer) is based on all information of which preparer has any knowledge4” under

penalties of perjury that the return is, to the best of the knowledge and belief, true, correct, and

complete.

A fundamental portion of preparer regulations has to do with the concept of reliance by the

preparer. The general rule is that the preparer may rely in good faith and without verification

upon information furnished by the taxpayer. The preparer is not required to audit, examine, or

review books and records, business operations, documents, or other evidence to verify

information provided by the taxpayer; however, the preparer may not ignore the implications of

information furnished by the taxpayer. The preparer must make reasonable inquiries if the

information as furnished appears to be incorrect or incomplete.5

Practical Example 2

It is the customary practice of the tax office to mail out tax organizers at the beginning of tax

season to all of the firm’s clients. The clients are requested to complete the organizer and return

it, when they come in for their interview. Mr. Johnson came for his appointment and as in

previous years, he brought his completed organizer. The preparer reviews a series of questions

that the tax software includes and asks a few questions from notes kept from the prior year. The

preparer then reviewed his documents. Everything was complete and a copy was kept of his W-2.

In reviewing his organizer, he had all the same interest and dividend payers as in previous years.

He did supply the 1099-INT and 1099-DIV. The taxpayer had answered the question that he had

not sold any stock during the year. The return was completed and he came in the office the next

week reviewed the return and signed Form 8879.

A few months after filing the return, Mr. Johnson received a CP2000 from the IRS regarding

missing dividends. The preparer checked his organizer and everything seemed to be in order.

Mr. Johnson called the tax preparer and said that in March 2013 he purchased several

additional shares of stock through E-trade. He had arranged for the dividends to be reinvested

and the 1099-DIV is in his E-trade account and not with his other stock holdings. The preparer

advised him to pay the amount as soon as possible.

As the preparer of the return due diligence was exercised by relying on his completed organizer

and the interview.

3 § 10.22 Diligence as to Accuracy

4 IRS 2013 Form 1040 5 §6694 1(e)1

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Ethics

A definition of “due diligence” for the purpose of tax preparation means the diligence or care

that a reasonable tax return preparer would use under the same circumstances. While court cases

relating to disciplinary or malpractice actions against preparers often refer to a preparer’s due

diligence, they do not appear to define the term in any manner that is unique to tax preparers.

10.22 (b) of Circular 230 discusses that a practitioner would have exercised due diligence if the

practitioner used reasonable care in evaluating the other practitioner and the work product he or

she supplied.

Practical Example 3

Jack, a tax preparer for many years, has rented an office in a small building that also has offices

including another tax preparer, a chiropractor, and an attorney. Many times, over the years, the

other preparer has asked Jack for assistance on some tax return issues and Jack has asked his

advice to determine if the issue on a particular return was being handled properly. He called

Jack’s office on March 30 and indicated that he had 10 returns where he had done the interview

and had completed the work papers. Since, all the information regarding the returns had been

gathered and Jack used the same software company, he asked if he would finish the returns. He

requested Jack sign them and answer any questions the taxpayer’s may have when they came to

pick up the returns. He contacted the clients, got proper permission to give Jack the information

and delivered the returns. Jack completed the returns from the work papers and only one of the

taxpayers had any additional questions, which was noted in the file.

Jack, using his colleagues work papers met the standards for due diligence.

Note: Jack could not have assisted his colleague with these returns if the colleague had been

under disbarment or suspension from practice before the Internal Revenue Service. A tax

practitioner cannot accept assistance from or assist any person who is under disbarment or

suspension if the assistance relates to a matter or matters constituting practice before the Internal

Revenue Service. Jack could not have relied on the other preparer’s work papers because that

would not have met the due diligence standard as described in §10.24 of Circular 230.

Practical Example 4

A taxpayer comes to the tax office when the preparer is unavailable; he has a packet of

documents, which he asks the receptionist to deliver. The receptionist asks the taxpayer if she

can make an appointment for him to come in for his tax interview. He declines and says the

packet of documents should be sufficient and to have the return prepared with those documents.

When the preparer reviews the documents, he notices the organizer is incomplete and he did not

have any interest or dividend statements in the package. The taxpayer had reported those items

in the previous year. The preparer contacts the taxpayer who instructs him to prepare the return

without that income. He fears he may owe tax and he will amend the return later. After a

discussion regarding reporting all income, the taxpayer says he will make an appointment soon,

but he would like to pick up his documents.

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Ethics

According to Circular 230 §10.28, at the request of a client, a tax preparer must promptly return

any and all records of the client that are necessary for the client to comply with his or her Federal

tax obligations. The practitioner may retain copies of the records returned to a client.

Records of the client include:

All documents or written or electronic materials provided to the practitioner, or obtained

by the practitioner in the course of the practitioner’s representation of the client, that pre-

existed the retention of the practitioner by the client.

The documents include materials that were prepared by the client at any time and

provided to the practitioner for tax preparation.

Also included is any return, claim for refund, schedule, affidavit, appraisal or any other

document prepared by the practitioner, or his or her employee or agent, that was

presented to the client with respect to a prior representation if such document is necessary

for the taxpayer to comply with current Federal tax obligations.

Fees

A practitioner’s fee must be reasonable in matters before the IRS. Contingent fees are only

allowed when the IRS is examining or challenging an original tax return; an amended return,

claim for a refund or credit where the amended return or claim was filed within 120 days of

taxpayer receipt of IRS examination notice. Contingent fees are also allowed for services to a

client in connection with the determination of interest or penalties assessed by the service and for

services provided with any judicial proceeding arising under the Internal Revenue Code.

Practical Example 5: A client in prior years has mailed his or her tax organizer and all

pertinent and required documents to the tax office for preparation of their tax returns, the client

picked up and reviewed the tax return and signed Form 8879 for electronic filing. No payment

was received at that time. Being a returning client the office policy is to proceed with the

electronically filing of his return. Even though the taxpayer was contacted many times, he never

paid his fee.

In late March 2014, he sent in his documents and a letter of instruction asking the preparer to

complete the return as soon as possible, but there was no payment for the prior year return. The

preparer spoke with the taxpayer who feels the fee charged in the prior year was too high. He

does not intend to pay all of it, wants the current year’s return completed, and then discuss the

matter. Since this is not the firm’s policy and the policy was clearly explained to the client, with

no resolution, his documents and notes should be returned to the taxpayer so he can meet the

filing deadline. The fee dispute for the prior year should be handled separately.

According to Circular 230 §10.28 the existence of a dispute over fees generally does not relieve

the practitioner of his or her responsibility to return documents to the taxpayer. Nevertheless, if

applicable state law allows or permits the retention of a client’s records by a practitioner in the

case of a dispute over fees for services rendered, the practitioner need only return those records

that must be attached to the taxpayer’s current return. The practitioner, however, must provide

the client with reasonable access to review and copy any additional records of the client retained

by the practitioner under state law that are necessary for the client to comply with his or her

Federal tax obligations.

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Ethics

NOTE: A tax organizer prepared by the preparer and completed by the client is considered material

prepared by the client; and must be returned to the client in a tax fee dispute.

Practical Example 6: For many years Anita, an enrolled agent, has completed the joint tax

return for Mr. Jones and Mrs. Jones. Much to her surprise, the Jones came to the office together,

and told Anita they have not lived together since May. They are not legally separated or divorce.

They want to file as Married Filing Separate. After a discussion with the Jones, Anita realized

they have some disagreements over their holdings. They are willing to waive any conflict of

interest, but Anita does not feel she can represent both of them to the best of her ability. Mrs.

Jones decides to retain another preparer; Anita provides her with a copy of the prior year return

and completes the return with Mr. Jones.

Conflict of Interest

According to Circular 230 §10.29 a conflict of interest exists if the representation of one client

will be directly adverse to another client (which in the circumstance above this would be the

case); or

The tax preparer could represent the taxpayer, if —

(1) The tax preparer reasonably believes that he or she will be able to provide competent

and diligent representation to each affected client,

(2) The representation is not prohibited by law; and

(3) Each affected client waives the conflict of interest and gives informed consent,

confirmed in writing by each affected client, at the time the existence of the conflict of

interest is known by the practitioner. The confirmation may be made within a reasonable

period after the informed consent, but not later than 30 days.

Copies of the written consents must be retained by the practitioner for at least 36 months from

the date of the conclusion of the representation of the affected clients, and the written consents

must be provided to any officer or employee of the Internal Revenue Service on request.

Practical Example 7: A new client comes to Smitty’s office to have his tax return prepared. After

the preparation of the return, the taxpayer tells Smitty he has some stock he wants to sell in the

current year and wants to know about the tax he may have to pay. He anticipates a gain of about

$10,000. Smitty had prepared his prior year return and correctly noted a $9,500 capital loss

carryover. $3,000 of that loss was used on the return that was just prepared. Smitty explains to

him that he can use this carryover loss to offset $6,500 of his gain and the remainder would be

taxed at 15% with his income. The taxpayer then tells Smitty that he would be willing to pay him

for some advice on which stock he should buy and asks him to do some research on three

different stocks. Smitty does not accept his offer and explains that this kind of research is not

directly related to the preparation of the tax return.

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Ethics

In the latest clarification from the IRS, Circular 230 §10.3(f)(3) states that tax return preparers

are allowed to provide advice to a client that is reasonably necessary to prepare a document

intended to be submitted to the IRS. Preparation of a tax return, claim for refund, or other

document intended to be submitted to the Internal Revenue Service for a current or future tax

period would meet that qualification. The taxpayer does not have to engage the preparer for the

period in question, but the information must be about a document intended to be submitted to the

IRS. In the example above the advice would not be related to a document intended to be

submitted to the IRS.

NOTE: The IRS has released final regulations6that eliminate the overly complex covered opinion

rules in Circular 230 by replacing them with a new competence standard. Section 10.35 now

requires practitioners to "possess the necessary competence to engage in practice before the

Internal Revenue Service" and states "competent practice requires the appropriate level of

knowledge, skill, thoroughness, and preparation necessary for the matter for which the

practitioner is engaged." The final rules also allow practitioners to remove the Circular 230

notices at the end of emails, which will make communications with clients less complex

Practical Example 8: According to the Office of Professional Responsibility the majority of

sanctions on preparers have been for failure to file their own tax returns

Circular 230 §10.50 and §10.51 state that incompetence and disreputable conduct for which a

practitioner may be sanctioned includes willfully not filing a Federal tax return and filing a

Federal income tax return in an untimely manner. This section pertains to tax preparers as well as

taxpayers. It is important that tax preparers understand the tax rules as interpreted by the IRS and

follow them. Below is a chart from OPR V. Timothy L Baldwin Complaint No. 2010-08:

6 TD 9668 June 12, 2014

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Timothy Baldwin, in the case above, was an attorney engaged in practice before the IRS and he

willfully failed to file his tax returns violating §10.51. Mr. Baldwin was suspended from practice

before the IRS, indefinitely. Reinstatement was left to the sole discretion of the Office of

Professional Responsibility.

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What Do You Think?

Q1. The following are correct regarding the PTIN, except?

A. Enrolled Agents are required by regulation to enter a PTIN on all

tax returns submitted to the IRS.

B. The PTIN program cannot be conditional upon testing and

continuing education.

C. The IRS requires all tax professionals who prepare taxes for

compensation to have a PTIN.

D. A fee is required for PTIN’s on an annual basis.

Q2. Which of the following is exempt and able to obtain the AFSP – Record of Completion

without taking the AFTR course?

A. A CTEC Registered tax preparer.

B. A VITA volunteer

C. Anyone who passed the Registered Tax Return Preparer test administered by the IRS

between November 2011 and January 2013.

D. All of the above are correct.

Q2. A client called and needed advice regarding Social Security Income and wanted to know

whether they should take early Social Security Benefits or wait until they reached full retirement

age. The client is single and has a small business, which for the last few years has earned a profit

of about $40,000 a year and investments of about $10,000. Which of the following would qualify

as best practices as described in Circular 230 §10.33?

A. Advise the client to go to Social Security website and use the calculator to see how the

benefits will be reduced due by taking early Social Security.

B. Review the tax return and call the client to determine when he is planning on retiring,

Discuss the reduction of social security benefits due to his net income from his business

and the reduction of benefits due to his age. With that information, refer him to the SSA

website for additional information.

C. Tell him the decision is his and if he needs the money he should apply.

D. None of the above.

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What Do You Think? - Answers

Q1: A is the correct answer,

EA’s who prepare tax returns for compensation are required to have a PTIN by

statute not by regulation.

The PTIN program now requires all tax professionals who prepare tax returns for compensation

to have a PTIN. Tax professionals must renew their PTIN’s annually. Currently the fee to renew

is $50.

Answer Q2 - D – Is the correct answer

Who is exempt and able to obtain the AFSP – Record of Completion without taking the

AFTR course?

• Anyone who passed the Registered Tax Return Preparer test administered by the IRS

between November 2011 and January 2013.

• Established state-based return preparer program participants currently with testing

requirements: Return preparers who are active members of the Oregon Board of Tax

Practitioners and/or the California Tax Education Council.

• SEE Part I Test-Passers: Tax practitioners who have passed the Special Enrollment Exam

Part I within the past two years as of the first day of the upcoming filing season.

• VITA volunteers: Quality reviewers and instructors with active PTINs.

• Other accredited tax-focused credential-holders: The Accreditation Council for

Accountancy and Taxation’s Accredited Business Accountant/Advisor (ABA) and

Accredited Tax Preparer (ATP) programs

Q3: B is the correct answer.

According to Circular 230 §10.33 Best Practices - tax preparers should provide clients with the

highest quality representation concerning Federal tax issues by adhering to best practices in

providing advice, as well as communicating clearly, establishing the relevant facts and advising the

taxpayer of the importance of the conclusions reached.

It is important that any questions asked of a tax preparer directly related to the tax return are

answered using current law and the best interest of the taxpayer. It is equally as important that

the preparer advise the client where additional information may be found, if applicable.

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Chapter Two - Statute of Limitations

Date Considered Filed

The IRS is subject to a statute of limitations for assessing taxes. Generally, taxes must be

assessed within three years of the due date of the return, or the date the return is filed, whichever

is later.7 The filing of a substitute return by the IRS does not start the running of the period of

limitations on assessment and collection. 8

Early filing of a return before the due date is considered filed by the due date. Late filing of a

return is considered filed on the date received by the IRS.

Mailbox Rule

If any document, which must be filed by a certain date, is delivered by U.S. mail after that date,

the date of the U.S. postmark stamped on the envelope is deemed to be the date of delivery.9 This

“mailbox rule” applies only in cases where the document is actually received by the IRS after the

statutory period. If a document is sent by registered or certified mail, this is evidence that the

document was delivered to the office to which it was addressed, and in that case the postmark is

deemed the date of delivery10.

The regulation provides that a private delivery service designated under criteria established by

the IRS will also constitute prima facie evidence of delivery. A list that the IRS accepts from

Notice 2015-38 is in the Update Section.

Common Law “Mailbox Rule”

It is the IRS's position that if a return was never received by the IRS and the taxpayer cannot

prove that it was mailed by registered mail, certified mail, or by a private delivery service

designated by the IRS, then the return was not timely filed. According to the IRS, Code Sec.

7502 preempts the "common law mailbox rule."

The common law mailbox rule was first acknowledged by the Supreme Court in Rosenthal v.

Walker, 111 U.S. 185 (1884). In that case, the Court held that if a letter properly addressed is

proved to have been either put into the post office or delivered to a postal worker, it is presumed,

that it reached its destination at the regular time, and was received by the person to whom it was

addressed. Therefore, the common law mailbox rule provides proof of mailing of a properly

addressed communication bearing proper postage create a presumption that the communication

was received.

7 IRC §6501(a) 8 Gleason v. Comm'r, T.C. Memo. 2011-154 9 IRC §7502(a) 10 IRC §7502 (c)

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The IRS's position that the common-law mailbox rule has been preempted by Code Sec. 7502

has been upheld by some circuit courts but rejected by others, thus creating a split in the courts.

In and, the Second and Sixth Circuits held

In the Deutsch case11, the taxpayer offered the affidavit of his accountant who stated he mailed a

copy of the relevant tax document within the prescribed time period. The Second Circuit held for

the IRS and stated that Code Sec. 7502 provided an easily applied, objective standard. A similar

conclusion was reached in the Miller case12, where the IRS records failed to establish a refund

claim was ever received. The Sixth Circuit rejected the taxpayer's offer of proof of timely

mailing to the IRS.

Relying on the Second Circuit's Deutsch decision, the Sixth Circuit concluded the only

exceptions to Code Sec. 7502's physical delivery rule were those found in the statute. However,

other circuit courts have concluded that where a taxpayer does not rely on Code Sec. 7502's

protection and produces evidence beyond their own testimony that it mailed the tax document

early enough to allow timely receipt by the IRS in the regular course of U.S. post office business,

the common law mailbox rule may be used.

E-file

A return that is filed using IRS e-file is considered filed on time if the authorized electronic

return transmitter postmarks the transmission by the return's due date. The electronic postmark is

a record of when the authorized electronic return transmitter received the transmission of the

electronically filed return on its host system. The date and time in the filer's time zone controls

whether the electronically filed return is timely.13

Deposits made by the Electronic Federal Tax Payment System

Deposits must be initiated by 8 pm ET at least one calendar day before the deposit due date to be

considered timely.

Extension of time to File

Individuals can request an automatic six-month extension of time to file their income tax returns.

For a calendar-year taxpayer, this would extend the due date for filing from April 15 to October

15.14 The automatic extension only extends the due date for filing the return - it does not extend

the due date for paying any tax due by the regular due date.

11 Deutsch v. Comm'r, 599 F.2d 44 (2d Cir. 1979) 12 Miller v. U.S., 784 F.2d 728 (6th Cir. 1986) 13 Reg. Sec. 301.7502-1(d)(1) 14 Reg. Sec. 1.6081-4(a)

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The extension request must show the full amount properly estimated as tax for the tax. The

Second Circuit has held that a taxpayer should be treated as having properly estimated his tax

liability when he or she makes a bona fide and reasonable estimate of his or her tax liability

based on the information available to the taxpayer at the time he or she requests the extension.15

This requires the taxpayer to judge or determine his or her tax liability generally, but carefully.

Thus, if a taxpayer, in a Form 4868 request for automatic extension, estimated his or her tax

liability to be zero, even though at the time the taxpayer submitted the request, he or she had

ample evidence discrediting the estimate, the Form 4868 would be invalid. Further, to be treated

as having properly estimated his or her tax liability, the taxpayer must make a bona fide and

reasonable attempt to locate, gather, and consult information that will enable the taxpayer to

make a proper estimate of his or her tax liability.

The IRS can terminate an automatic extension at any time by mailing the individual a notice of

termination at least 10 days before the termination date designated in the notice. The IRS must

mail the notice of termination to the address shown on the Form 4868 or to the individual's last

known address.

Six-Year Statute for Certain Omissions from Gross Income

If a taxpayer omits an amount from gross income that is properly includible in gross income and

that amount is in excess of 25 percent of the gross income stated in its return, the statute of

limitations on the assessment of taxes is extended from three years to six years16

For returns filed after July 31, 2015, an understatement of gross income by reason of an

overstatement of unrecovered cost or other basis is an omission from gross income for purposes

of the extended six year limitations period.17

Prior to the enactment of Pub. L. 114-41 (7/31/15) , which modified Code Sec. 6501(e)(1)(B) as

noted above, Previously, there was considerable controversy over whether or not an

overstatement of basis on the sale of property, which reduces gain reported on a tax return,

constitutes an omission from gross income that triggers the six-year statute.

There are several cases where the courts seem to be at odds in this area. The two cases most

often referred to are the following:

In Colony, Inc. v. Comm'r, 357 U.S. 28 (1958), the Supreme Court held that an overstatement of

basis was not an omission from gross income that triggered the longer statute of limitations. The

IRS argued that the Supreme Court's decision in Colony no longer applied as a result of changes

to Code Sec. 6501(e)(1)(A). Some courts agreed, other courts concluded that the Colony decision

did still apply and an overstatement of basis was not an omission of gross income.

15 Berlin v. Comm'r, 59 F.2d 996 (2d Cir. 1932) 16 (Code Sec. 6501(e)(1); 6229(c)(2)). 17 Code Sec. 6501(e)(1)(B)

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The IRS then issued regulations defining "omission from gross income" and "gross income" for

purposes of determining whether the six-year statute of limitations should be applied. As a result

of the conflicting court opinions on whether an overstatement of basis triggered the extended

statute of limitations and whether the IRS could essentially issue regulations overruling court

decisions it did not agree with, the Supreme Court agreed to hear one of the cases.

In U.S. v. Home Concrete & Supply, LLC, 2012 PTC 94 (S. Ct. 2012), the Supreme Court

affirmed a Fourth Circuit decision which, rejected IRS assertions that an overstatement of basis

on the sale of property triggers the six year statute of limitations. The Supreme Court relied on its

decision in Colony, Inc. v. Comm'r, 357 U.S. 28 (1958).

According to the Supreme Court, its prior decision in Colony had already interpreted the statute.

Thus, the Supreme Court's decision invalidated the portion of the regulations that said an

overstatement of basis was considered in calculating an omission of gross income. The Court

determined that an "understatement" of basis was not an "omission" for purposes of the statute.

In reaching this decision, the Court looked at the legislative history of the provision and

concluded that Congress intended an exception to the usual three-year statute of limitations only

in a restricted type of situation - a situation that did not include overstatements of basis. As a

result, of the decision, the taxpayers were allowed to avoid certain taxes because the IRS did not

discover their overstated basis until after the normal three-year period.

In July, 2015 Congress effectively reversed the Supreme Court's holding. In the Surface

Transportation and Veterans Health Care Choice Improvement Act of 2015, Congress amended

Code Sec. 6501 to clarify that an understatement of gross income because of an overstatement of

unrecovered cost or other basis is an omission from gross income for purposes of the six-year

statute of limitations.

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What Do You Think?

Q1. The “mailbox rule” applies only in cases where the document

__________________after the statutory period

A. Is mailed

B. Is sent be private courier

C. Is actually received by the IRS

D. None of the above

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What Do You Think? - Answers

Answer Q1 – C Is the correct answer

If any document, which must be filed by a certain date, is delivered by U.S. mail

after that date, the date of the U.S. postmark stamped on the envelope is deemed

to be the date of delivery.18 This “mailbox rule” applies only in cases where the

document is actually received by the IRS after the statutory period. If a

document is sent by registered or certified mail, this is evidence that the document was delivered

to the office to which it was addressed, and in that case the postmark is deemed the date of

delivery19.

18 IRC §7502(a) 19 IRC §7502 (c)

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Chapter Three - Disclosure, Document Protection and Rules

Internal Revenue Code §7216

On January 1, 2009, tax return preparers became

subject to many additional rules regarding the use

and disclosure of their clients’ tax return

information. These new rules and restrictions

create everyday problems by complicating a tax

preparer’s ability to use or disclose return

information.

These changes made it very difficult for any tax preparer to share tax return information with

anyone other than the IRS or state taxing authorities without obtaining a taxpayer’s consent.

Disclosure regulations under Internal Revenue Code §7216 became effective January 1, 2009.

The regulations give taxpayers greater control over their personal tax return information. The

statute limits tax return preparers’ use and disclosure of information obtained while preparing a

taxpayer’s return to activities directly related to the preparation. The regulations describe how

preparers, with the informed written consent of taxpayers, may use or disclose return information

for other purposes. The regulations also describe specific and limited exceptions that allow a

preparer to use or disclose return information without the consent of taxpayers.

Consents to disclosure of a taxpayer’s tax return information – paper or electronic – must contain

certain specific information. Every consent form must include:

Tax preparer name and the taxpayer’s name

The nature of the disclosure and intended purpose

To whom the disclosures will be made

Details on the information being disclosed

The particular use authorized

The product or service for which the tax return information will be used.

Expansion of the definition of “return preparer”

The new rules apply only to “return preparers.” Tax return preparers for this purpose are defined

as persons who participate in the preparation of tax returns for taxpayers. These include, but are

not limited to:

Return preparers who are in business or hold themselves out as preparers.

Casual preparers who are compensated for their services

E-file providers

Electronic return originators and electronic return transmitters

Intermediate service providers

Software developers

Reporting Agents

Objective

Identify when a consent for disclosure is

required.

Awareness that specific wording must be

included in a consent to use or disclose

form.

Recognize the importance of protecting

taxpayer data.

Adherence to the appropriate tax preparer

conduct

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The definition of a “return preparer” also now extends to those who assist the tax preparer in

preparing returns, such as tax preparers’ employees who perform services in connection with the

preparation of a tax return, and those individuals outside the office who perform services in

connection with the preparation of return.

IRC § 7216 - Related to the Affordable Care Act

Internal Revenue Code § 7216 is a criminal provision enacted by the U.S. Congress in 1971 that,

except as provided in regulations, prohibits tax return preparers from knowingly or recklessly

disclosing tax return information or using tax return information for a purpose other than

preparing, or assisting in preparing, an income tax return. This provision applies to tax return

preparers who also offer services and education related to the Affordable Care Act. Violators are

subject to a $1,000 fine or a year in prison, or both.

The regulations under § 721620, were issued as final regulations effective on Dec. 28, 2012.

In addition to criminal penalties, a civil penalty of $250 for each unauthorized disclosure or use

of tax return information by a tax return preparer may be imposed21. The total amount imposed

on any person shall not exceed $10,000 in any calendar year.

The IRS takes the privacy rights of America's taxpayers very seriously and is committed to

protecting those rights. Section 7216 prohibits tax return preparers, including those who also

offer services and education related to the Affordable Care Act, from knowingly or recklessly

disclosing or using tax return information for unauthorized purposes.

The tax return information a tax return preparer can disclose or use depends on whether the

preparer obtains consent from the taxpayer, or whether Treas. Reg. § 301.7216-2 provides an

exception to the general prohibition on disclosure or use of tax return information without

taxpayer consent.

The §7216 regulations permit tax return preparers to use a list of client names, addresses, email

addresses, phone numbers and each client’s income tax form number to provide clients general

educational information, including general educational information related to the Affordable

Care Act.

Example: A tax return preparer may mail general educational information to all clients

regarding health care enrollment options available through the new health insurance

marketplaces without obtaining consent.

Tax return preparers who use tax return information to solicit and facilitate health care

enrollment services must first obtain taxpayer consent to do so.

20 Treas. Reg. §§ 301.7216-1 to 301.7216-3 21 IRC §6713

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Example: Return Preparer Joe is also a health care "navigator" who would like to use tax

return information22, to solicit and facilitate enrollment of eligible clients into qualified health

plans available through the new health insurance marketplaces. Joe must obtain taxpayer

consent prior to using the tax return information in assisting taxpayers in connection with the

solicitation and facilitation of the enrollment of Joe’s eligible clients into qualified health care

plans. See Rev. Proc. 2013-14 (I.R.B. 2013-3, Jan.4, 2013 for information regarding the

qualification requirements for health care navigators, agents, or brokers visit healthcare.gov.

Starting Jan.1, 2014, tax return preparers must use the mandatory language in Rev. Proc. 2013-

14. See Rev. Proc. 2013-19.

Revenue Procedure 2013-1423

This Rev. Proc supersedes and modifies the rules issued in 2008-35 (effective Jan 14, 2013) The

IRS has provided guidance to tax return preparers about the format and content of taxpayer

consents to disclose and consents to use tax return information and modified the mandatory

language required on each taxpayer consent. The guidelines applies to individuals filing a return

in the Form 1040 series. The revenue procedure also lists specific requirements for electronic

signatures when a taxpayer executes an electronic consent to the disclosure or consent to the use

of the taxpayer’s tax return information.

In the revenue procedure, the IRS says that some taxpayers have expressed confusion over

whether they must complete consent forms to engage a tax return preparer to perform tax return

preparation services. The modified mandatory language required in consent forms clarifies that a

taxpayer does not need to complete a consent form to engage a tax return preparer to perform

only tax return preparation services. One example in the revenue procedure provides that if a tax

return preparer makes provision of tax preparation services contingent on the taxpayer’s signing

a consent, the consent is not valid because it is not voluntary. However, a taxpayer must

complete a consent form as described in the revenue procedure to allow a tax return preparer to

disclose or use tax return information in providing services other than tax return preparation.

IRC §7216 prohibits a tax return preparer from “knowingly or recklessly” disclosing or using tax

return information. A violation could result in a preparer’s being charged with a criminal

misdemeanor, involving a maximum penalty of $1,000 or one year in prison, or both, plus costs

of prosecution.

Under the revenue procedure, each separate consent to disclosure or use of tax return information

must be contained on a separate written document (either paper or electronic). The separate

written document may be provided as an attachment to an engagement letter furnished to the

taxpayer.

22 Treas. Reg. §301.7216-1(b)(3), 23 Appendix Rev Proc 2013-14

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The revenue procedure prescribes the required paper size and font size for consents on paper. For

electronic consents, the revenue procedures requires the consent to appear on its own screen,

prescribes the text size, and says there must be sufficient contrast between the text and

background colors.

The revenue procedure provides mandatory statements that must be included in a consent in

various circumstances, including:

1. Consent to disclose tax return information in a context other than tax return preparation

or auxiliary services;

2. Consent to disclose tax return information in the context of tax return preparation or

auxiliary services; and

3. Consent to use tax return information.

All consents must also contain the following statement:

If you believe your tax return information has been disclosed or used improperly in a

manner unauthorized by law or without your permission, you may contact the Treasury

Inspector General for Tax Administration (TIGTA) by telephone at 1-800-366-4484, or

by email at complaints@tigta.treas.gov.

The revenue procedure also provides mandatory language to be included in any consent

to disclose tax return information to a tax return preparer located outside the United

States.

All consents must require the taxpayer’s affirmative consent to a tax return preparers’

disclosure or use of tax return information. An “opt-out” consent, which requires the

taxpayer to remove or deselect disclosures or uses that the taxpayer does not wish to be

made, is not permitted. For an electronic consent to be valid, it must be furnished in a

manner that ensures the taxpayers’ affirmative, knowing consent to each disclosure or

use.

All consents to disclose or use of tax return information must be signed by the taxpayer.

For consents on paper, the taxpayer’s consent to a disclosure or use must contain the

taxpayer’s handwritten signature. For electronic consents, a taxpayer must sign the

consent by any method prescribed in Rev. Proc. 2013-14. (See Appendix)

A tax return preparer may not alter a consent form after the taxpayer has signed the document;

therefore, a tax return preparer cannot present a taxpayer with a consent form containing blank

spaces for completing the spaces after the taxpayer has signed the document.

Practical Example 9: The tax preparer does not acquire a consent form from a taxpayer when

a draft of the taxpayer's Schedule C is requested by the retirement administrator to determine

the amount of retirement contribution that can be contributed by the taxpayer.

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In this case, the tax preparer did not meet any of the exceptions. Disclosure of tax return

information to a taxpayer’s retirement administrator does not fit within any of the exceptions

under the second revised Regulation (301.7216-2) to the requirement of prior written consent.

Accordingly, the taxpayer should have a signed consent form before the preparer made the

disclosure.

The following are the items listed in Reg. §301.7216-2 allowing a tax preparer to disclose tax

information without written consent:

A. Disclosure pursuant to other provisions of the Internal Revenue Code.

B. Disclosures to the IRS. NOTE: If doing a state return for the taxpayer, information may

be disclosed to a state taxing authority.

C. Disclosures or uses for preparation of a taxpayer's return—

a) Updating Taxpayers' Tax Return Preparation Software.

b) Tax return preparers located within the same firm in the United States.

Practical Example 10: A taxpayer sent an email to his tax preparer, which read: “I'm in the

process of refinancing my home loan, and if the mortgage company calls, please provide them

with whatever they request”. The tax preparer prints the email and puts it in the client’s file.

When the mortgage lender calls a week, later the preparer gives the information the lender

requests.

Again, the preparer did not meet the requirements of §7216 or Rev Proc. 2013-14. The preparer

should have sent the appropriate consent form to the taxpayer for signature. The preparer should

not provide any tax return information to the third party until the preparer received the signed

consent form from the taxpayer. A letter, email, or note is not sufficient.

Adequate data protection safeguards A tax return preparer located within the United States, including any U.S. territory or possession,

may disclose a taxpayer’s Social Security number to a tax return preparer located outside the

United States or any U.S. territory or possession with the taxpayer’s consent. Both the tax return

preparer located within the United States and the tax return preparer located outside the United

States must maintain an “adequate data protection safeguard”, at the time the taxpayer’s consent

is obtained and when making the disclosure.

The revenue procedure describes an “adequate data protection safeguard” as the following:

a) An implemented security program, which is explained to all employees and monitored by

management, and

b) A written policy put into practice and reviewed, and

c) It must include technical and physical safeguards to protect tax return information from

misuse, unauthorized access, or disclosure, and

d) It must follow and conform to one of the data security frameworks described in the

revenue procedure24.

24 IRS Publication 1075, Tax Information Security Guidelines for Federal, State and Local Agencies and Entities

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Electronic signatures 1. For electronic consents, the tax return preparer must obtain the taxpayer’s signature on

the consent in one of the following ways:

2. Assign a personal identification number (PIN) that is at least five characters long to the

taxpayer.

3. Have the taxpayer type in the taxpayer’s name and then select “enter” to authorize the

consent. (The software must not automatically furnish the taxpayer’s name so that the

taxpayer only has to click a button to consent.)

4. Any other manner in which the taxpayer affirmatively enters five or more characters

unique to the taxpayer that the tax return preparer uses to verify the taxpayer’s identity.

Document Rules25

The revenue procedure includes three examples showing the application of its rules.

A tax preparer cannot willfully sign a tax return or advise a taxpayer knowing that the

return, documentation, or other submitted papers lack a reasonable basis or if the tax

preparer should have known the information lacks a reasonable basis.

The tax preparer cannot take an unreasonable position, or a willful attempt to understate

the tax liability or a reckless disregard of rules by the preparer.

A tax preparer may not advise a client to take a frivolous tax position on any document

affidavit or other submitted papers.

Practical Example 11: A taxpayer comes to a tax preparer, he is divorced and his child lives all

year with his ex-wife. He instructs the preparer to claim the child as his dependent because he

pays child support.

This would be an unreasonable position and should be explained to the taxpayer. The tax

preparer should not take this position on the tax return because the child did not live with the

taxpayer during the year and there is no reasonable basis to take the child as a dependent.

Any penalties that are likely to be applied must be communicated to the taxpayer by the tax

preparer if the tax preparer advised the taxpayer with respect to the position, prepared or signed

the tax return or any other document submitted to the IRS. The tax preparer can rely on

information provided by the taxpayer without verification, but the tax preparer may not ignore

implications of information furnished that appear to be incorrect or inconsistent with other

factual assumptions.

25 IRC §6694

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Practical Example 12: Use the same facts as in practical example 11. Also, assume the taxpayer

is not satisfied with the answer and says he will do his own return, because the preparer will not

sign the return with an unreasonable position. The preparer tells the taxpayer that if he

knowingly claims a child that is not considered his dependent, the taxpayer will be subject to

penalty and his position will not be sustained.

A tax preparer advising a taxpayer to take a position on a tax return, document, affidavit or other

paper submitted to the Internal Revenue Service, or preparing or signing a tax return as a

preparer, generally may rely in good faith without verification upon information furnished by the

taxpayer. The tax preparer may not, however, ignore the implications of information furnished

to, or actually known by, the tax preparer, and must make reasonable inquiries if the information

as furnished appears to be incorrect, inconsistent with an important fact or another factual

assumption, or incomplete.

Penalties The new rules have criminal as well as civil penalties that can apply. Further, violations can be

sanctioned by restriction on a practitioner’s right to practice before the IRS.

A civil penalty is imposed under IRC §6713(a) for unauthorized disclosures or uses of

information furnished in connection with the preparation of an income tax return. The penalty for

violating IRC §6713 is $250 for each disclosure or use, not to exceed a total of $10,000 for a

calendar year. IRC §7216 imposes a criminal penalty on tax return preparers who knowingly or

recklessly make an unauthorized use or disclosure of tax return information provided to them in

connection with the preparation of an income tax return. A maximum $1,000 fine or

imprisonment of no more than one year, or both, may be imposed for each violation.

Federally Authorized Tax Practitioner-Client Privilege26

Generally, with respect to tax advice, the same common law protections of confidentiality

applies. The privilege which applies to a communication between a taxpayer and an attorney

shall also apply to a communication between a taxpayer and any federally authorized tax

practitioner to the extent the communication would be considered a privileged communication if

it were between a taxpayer and an attorney. The privilege may only be asserted in any

noncriminal tax matter before the Internal Revenue Service and any noncriminal tax proceeding

in Federal court brought by or against the United States

The term federally authorized tax practitioner means any individual who is authorized under

Federal law to practice before the Internal Revenue Service.27 The term tax advice means advice

given by an individual with respect to a matter, which is within the scope of the individual's

authority to practice.

26 IRC §7525 27 USC §330

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NOTE: Be cautious, this is an area where the IRS usually prevails; there is a difference between

tax preparation and tax advice. Items which are entered on a tax return and submitted to the IRS

cannot be considered privileged.

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What Do You Think?

Q1. Which of the following are correct regarding a consent to disclose in Rev

Proc. 2013-14?

A. A tax return preparer makes provision of tax preparation services

contingent on the taxpayer’s signing a consent. The consent is not valid

because it is not voluntary.

B. A taxpayer must complete a consent form as described in the revenue

procedure to allow a tax return preparer to disclose or use tax return

information in providing services other than tax return preparation.

C. A taxpayer does not need to complete a consent form to engage a tax return preparer to

perform only tax return preparation services.

D. All of the above

Q2. Which of the following is a correct statement?

A. If the taxpayer insists, the tax preparer must sign the return even if the preparer has

reasonable knowledge that information supplied is incorrect.

B. If a taxpayer is self-employed, the tax preparer must audit the taxpayer’s books to

complete the tax return.

C. The tax preparer can rely on information provided by the taxpayer without verification.

D. The tax preparer does not have to advise a taxpayer of potential penalties on a position, if

the return is going to be filed with the IRS

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What Do You Think? – Answers

Answer Q1: D All of the items are correct. In Rev Proc. 2013-14, the IRS says that some taxpayers have expressed confusion

over whether they must complete consent forms to engage a tax return preparer to

perform tax return preparation services.

The modified mandatory language required in consent forms clarifies that a taxpayer does

not need to complete a consent form to engage a tax return preparer to perform only tax

return preparation services.

The revenue procedure provides that if a tax return preparer makes provision of tax

preparation services contingent on the taxpayer’s signing a consent, the consent is not

valid because it is not voluntary.

A taxpayer must complete a consent form as described in the revenue procedure to allow a tax

return preparer to disclose or use tax return information in providing services other than tax

return preparation.

Answer Q2: C is the correct answer.

According to §6694, any penalties that are likely to be applied must be communicated to the

taxpayer by the tax preparer if the tax preparer advised the taxpayer with respect to the position,

prepared or signed the tax return or any other document submitted to the IRS. The tax preparer

can rely on information provided by the taxpayer without verification, but the tax preparer may

not ignore implications of information furnished that appears to be incorrect or inconsistent with

other factual assumptions.

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Chapter Four - Sanctions for the Violation of Regulations

Circular 230 §10.50 Sanctions

Circular 230 §10.50 gives the OPR the authority to

censure, suspend or disbar any practitioner from

practice before the IRS if he or she fail to comply

with the conduct of standards. Monetary penalties may also be assessed to individuals and/or

firms who violate these provisions.

Circular 230, Subchapter C §10.51- Incompetence and disreputable conduct.

The following is an overview of §10.51 Incompetence and disreputable conduct for which a

practitioner may be sanctioned includes but is not limited to —

Conviction of any criminal offense under the Federal tax laws.

Giving false or misleading information to the Department of the Treasury or any

officer or employee or facts or other matters contained in Federal tax returns,

financial statements and any other document or statement, written or oral, which

are included in the term “information.”

Failing to file a Federal tax return in violation of the Federal tax laws, or willfully

evading or attempting to evade any assessment or payment of any Federal tax.

Assisting, counseling, encouraging a client in violating, or suggesting to a client

or prospective client to violate, any Federal tax law; or knowingly counseling or

suggesting to a client or prospective client an illegal plan to evade Federal taxes

or payment.

Tax Law Case 10-243 - USA v. Mobley

Tax preparer Alice Mobley, paid $10 to $20 per person to a friend to gather social security

numbers to use fraudulently on tax returns. Those selling their information were paid $500 for

adult numbers and $600 for children’s’ numbers. Mobley’s Preyear Tax and Check Cashing in

Atmore Mobley’s home and other business locations were raided by federal agents on March 4,

2010. Investigators found complete identification information on 536 people, including Social

Security cards, Medicaid cards and other documents.

Mobley also “split” dependents, using the identity of some children on one return to obtain

Earned Income Credit, and on other returns to obtain Child Credit and Dependent Care Credits.

Mobley’s firm also prepared returns, which claimed business tax deductions for business, which

did not exist and farm tax deductions for clients who did not have farms.

Objective

Recognize what constitutes

misconduct in a tax preparer

Understand the importance of Form

8275 – Disclosure Statement

Understand the importance of being

an informed tax preparer.

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The following can be basis for sanctions:

Although “trade or business” is one of the most widely used terms in the IRC, neither the Code

nor the Treasury Regulations provide a definition. The definition of a “trade or business” comes

from common law, where the concepts have been developed and refined by the courts. The

Supreme Court has interpreted “trade or business” for purposes of IRC §162 to mean an activity

conducted with “continuity and regularity” and with the primary purpose of earning income or

making profit.28

A court considers damage awards for emotional distress to be excludible from

income.

National Taxpayer Advocate – Report to Congress

The National Taxpayer Advocate’s Annual Report to Congress identifies the most serious

problems facing taxpayers and recommends solutions to those problems. §7803(c)(2)(B)(ii) of

the Internal Revenue Code requires the National Taxpayer Advocate to submit this report each

year and in it, among other things, to identify at least 20 of the most serious problems

encountered by taxpayers and to make administrative and legislative recommendations to

mitigate these problems. Nina Olsen is the National Taxpayer Advocate.

Nina Olson’s job, as the National Taxpayer Advocate, is to discover any way in which the IRS

bureaucracy or the tax laws passed by Congress are harming taxpayers. Tax-filing season is

when those problems are most easily detected.

An analysis of IRS data by the Office of the Taxpayer Advocate shows it takes U.S. taxpayers

more than 6.1 billion hours to complete filings required by a tax code that contain almost four

million words and that, on average, has more than one new provision added to it daily. Indeed,

few taxpayers complete their returns without assistance. Nearly 60 percent of taxpayers hire paid

preparers and another 30 percent of people rely on commercial software to prepare their returns.

To inspire confidence and trust, the tax laws should be comprehensible and the computations of

tax should be transparent and relatively simple, yet few taxpayers today can confidently say they

understand the tax code or even that they have correctly computed their tax liabilities.

The office is located within the IRS, but independent of its authority. The Taxpayer Advocate

Service helps taxpayers with liens or delayed refunds navigate the IRS.

Congress created the office of the National Taxpayer Advocate in 1996 as a resource for

taxpayers with “significant hardship[s]” like extraordinary delays, legal threats or substantial

costs. Olson says she is placing particular attention now on fraud.

Only the most serious cases get elevated to Olson’s desk. Last year 26 of the “taxpayer

assistance order” cases she saw focused on fraud, specifically tax preparer fraud. In the previous

few years, she had 10 cases elevated to her desk.

28 Taxpayer Advocate ARC 2012

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The Office of the Taxpayer Advocate also analyzes the most litigated issues each year. The

Report to Congress discusses this litigation and shows the court cases that were analyzed. This

gives unique insight to the tax preparer on how the IRS looks at different situations. The

following is an overview of some of the litigated issues from National Tax Advocate’s Annual

Report to Congress.

Accuracy Related Penalty

Many different circumstances can result in an accuracy related penalty for the taxpayer or for the

tax preparer. A common defense against the accuracy-related penalty is reliance on tax software

The IRS and court decisions have sustained accuracy related penalties where the taxpayer or

preparer relies on the software. 66% of the time when the taxpayer or tax preparer blamed

software for inaccuracy, the penalty was sustained by the court. The court and the IRS essentially

followed the garbage-in and garbage-out philosophy. To blame the computer software the

taxpayer or preparer needs to show it was a software error and not the tax preparer or the

taxpayer’s failure to enter the information in the proper manner29.

Another example of an accuracy related penalty is Andrew Dean Shelton v. Commissioner30

The Tax Court considered whether a $25,000 cash payment made pursuant to a marital

settlement agreement was alimony deductible by the petitioner. The divorce decree entered in

2007 by an Illinois Circuit Court stated that each party was barred from asserting any claim “for

maintenance, formerly known as alimony.” The petitioner paid the $25,000 in 2007 and deducted

the full amount as alimony. The IRS issued a statutory notice disallowing the deduction and

asserted the accuracy –related penalty under §6662(a).

The court ruled that the payment was not deductible alimony,31 and as such not deductible. The

court held that the Illinois divorce court did designate the payments as non-deductible/ non-

taxable by stating in its order that each party was barred from asserting any claim for

maintenance, formerly known as alimony.

The court in Shelton upheld the accuracy-related penalty for negligence or intentional disregard

of the rules or regulations. The court found, based on the evidence, that petitioner did not act

with reasonable cause and in good faith. The court based is finding on the fact that the Illinois

court explicitly stated that neither party was entitled to alimony, yet petitioner “proceeded to

claim an alimony deduction.”

29 Brenda F Bartlett v. Commissioner TC Memo 2012-254 30 T.C. memo 2011-266 31 Section 215(See section 71(b) (1) (B)).

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Trade or Business Expenses Under IRC §162 and Related Sections

Internal Revenue Code §162 allows deductions for ordinary and necessary trade or business

expenses paid or incurred during the course of a taxable year. Rules regarding the practical

application of IRC §162 have largely come from case law. The IRS, the Department of the

Treasury, Congress, and the courts continue to provide guidance about whether a taxpayer is

entitled to claim certain deductions.32 In the following paragraphs, we show many court cases,

which demonstrate “ordinary” and “necessary” and some of the evolution of the term.

The majority of gross income cases this year involved taxpayers failing to report items of

income, including some specifically mentioned in IRC §61 such as wages, interest, dividends,

and annuities. Although “trade or business” is one of the most widely used terms in the IRC,

neither the Code nor the Treasury Regulations provide a definition. The definition of a “trade or

business” comes from common law, where the concepts have been developed and refined by the

courts. The Supreme Court has interpreted “trade or business” for purposes of IRC §162 to mean

an activity conducted with “continuity and regularity” and with the primary purpose of earning

income or making profit.33

IRC §162(a) requires a trade or business expense to be both “ordinary” and “necessary” in

relation to the taxpayer’s trade or business in order to be deductible.

In Welch v. Helvering, the Supreme Court stated that the words “ordinary” and “necessary” have

different meanings, both of which must be satisfied for a taxpayer to benefit from the deduction.

The Supreme Court describes an “ordinary” expense as customary or usual and of common or

frequent occurrence in the taxpayer’s trade or business. The Court describes a “necessary”

expense as one that is appropriate and helpful for development of the business.

Common law also requires that in addition to being ordinary and necessary, the amount of the

expense must be reasonable for the expense to be deductible.

In Commissioner v. Lincoln Electric Co., the Court of Appeals for the Sixth Circuit held there

must be an element of reasonableness in the term ‘ordinary and necessary.’ There is no express

statutory provision limiting it to a reasonable amount. The element of reasonableness is inherent

in the phrase "ordinary and necessary." It was not the intention of Congress to allow as

deductions operating expenses incurred or paid by the taxpayer in an unlimited amount34. The

taxpayer is required to have receipts and to be able to demonstrate its business use or

relationship.

Example 15: Jack has a small realty office; his cat comes with him to the office every day. Jack

list as a deduction the cat’s food and veterinary bills. The preparer tells Jack these items cannot

be deducted because he cannot show a business purpose related to his realty business.

32 Taxpayer Advocate ARC 2012 33 Taxpayer Advocate ARC 2012 34 IRC §§104, 105,6601

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This is the most prevalent issue was the substantiation of claimed trade or business expense

deductions, which appeared in 13 cases.

For example: In Lyseng v. Commissioner35, the Tax Court denied several deductions for lack of

substantiation, including depreciation on a travel trailer, laundry services, vehicle permit costs,

and towing expenses. The taxpayer provided no evidence to substantiate the laundry, vehicle,

and towing expenses, and, therefore, the court disallowed the deductions. Concerning the

depreciation deduction, the taxpayer provided no evidence substantiating the trailer has cost

basis — no bill of sale, canceled check, or third party corroborating testimony. The Tax Court

did find that the taxpayer substantiated the deductions for unreimbursed automobile expenses

and some union dues. The taxpayer kept a mileage record with the dates of travel and provided

credible testimony regarding the business purpose of each trip he took for his employer. A pay

stub from an employer, combined with credible taxpayer testimony, also convinced the court to

allow some of the union dues.

Even when the individual taxpayer maintains records to substantiate a deduction, he or she still

has to prove the expense is ordinary and necessary to a trade or business.

In Farias v. Commissioner36, the taxpayer was a teacher who claimed deductions for

unreimbursed employee expenses for the purchase of a specialty chair, an adjustable headrest, a

pillow, and ice/heat pads. The taxpayer claimed she purchased the items because she suffered a

back injury when she moved her classroom. The taxpayer also taught fitness classes and claimed

deductions for fitness items, including clothing. The IRS denied the deductions because the

purchases were not ordinary and necessary to her teaching position. The Tax Court also

disallowed the taxpayer’s deductions for fitness expenses because she failed to describe the items

purchased and to prove the clothing was ordinary and necessary in her trade or business. The

court further determined the clothing deduction was not allowable because the clothing was

suitable for general use

Kennedy v. Commissioner37 Shows the general rule that where business clothes are suitable for

general wear, a deduction for the clothes is not allowable. Refer to Donnelly v. Commissioner,38

in which such costs are not deductible even when it has been shown that the particular clothes

would not have been purchased but for the employment.

Example 16: A police officers uniform, which he pays for without reimbursement, is deductible.

The detective’s suit (which he can wear to either work or elsewhere) is not deductible.

The tax preparer should assist the taxpayer in determining whether their business expenses are

ordinary and necessary under IRC § 162. The Internal Revenue Code defines business expenses

as the ordinary and necessary expenses of carrying on a trade or business. Generally, business

35 T.C. Memo. 2011-226. 36 T.C. Memo. 2011-248. 37 T.C. Memo. 1970-58, affd. 451F.2d 1023 (3d Cir. 1971) 38 262 F.2d 411 (2d Cir. 1959), affg. 28 T.C. 1278 (1957)

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expenses are tax deductible. However, the IRS does not provide a compendium of general

business expenses, leaving it to the taxpayer to define from the criteria what is ordinary and

necessary. In fact, the terms ordinary and necessary were not defined in the original statute

establishing the Internal Revenue Code, leaving it to the tax courts to establish their meanings

through case law.

This case's interpretation of the word necessary is referenced repeatedly in subsequent court

cases involving taxation. Welch v. Helvering39, references McCulloch v. Maryland in its

assumption "that the payments to creditors were necessary for the development of the petitioner's

business, at least in the sense that they were appropriate and helpful." In 1983, Rothner v.

Commissioner40, adds that an expense is not necessary "simply because the taxpayer could have

avoided it by pursuing a different course of conduct", further reinforcing a less rigorous

interpretation of its meaning.

In Welch v. Helvering, the court also stated that the term ordinary has some consistency but is

nonetheless a variable affected by time, place and circumstance" and does not mean it must be

habitual. There is not one standard that defines ordinary. Accuracy-related penalties have

Practical Example 17: A plumbing service ordered two cases of aftershave and new shirts for

the 35 plumbers that worked for the service. Although the aftershave and shirts were not

required, the owner (and some customers) found it necessary.

In Deputy v. DuPont41 the Supreme Court defined ordinary as “normal, usual, or customary”,

reaffirming Welch V. Helvering by explaining, that though an expense happened but once in the

taxpayer's lifetime, if the transaction giving rise to it is of "common or frequent occurrence in the

type of business involved", it is ordinary. It concludes that the kind of transaction from which the

obligation arose in the particular business is crucial in determining whether the expense is

ordinary and, deductible by the taxpayer. In Commissioner v. Heininger42defines the term

"normal" as used in the prior two court opinions quoted above in their definition of ordinary, as

an expense arising "from an action that is ordinarily to be expected of one in the taxpayer's

position".

To be deductible, a business expense must be both ordinary and necessary. An ordinary expense

is one that is common and accepted in that trade or business. A necessary expense is one that is

helpful and appropriate for that trade or business. An expense does not have to be indispensable

to be considered necessary.

From this definition and the tax court rulings, we can draw the following conclusions.

Both criteria, ordinary and necessary, need to be met for the expense to be deductible.

39 Supreme Court 290 U.S. 111 (1933) 40 United States Tax Court, T.C. Memo. 1996-442, Docket No. 26134-93 41 Supreme Court 308 U.S. 488, 495 (1940), 42 Supreme Court, 320 U.S. 467 (1943)

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For an expenditure to be an ordinary expense, it must be a common or usual expense in

one's business and an acceptable or customary expense for one's business.

Practical Example 18: If a plumber claims the purchase of window curtains as a deduction on

his tax return it would not be considered an ordinary and necessary expense.

However, if an interior decorator purchases window curtains, they may easily be a legitimate

business deduction. Their purchase would be both a common and an acceptable expenditure in

the conduct of their services.

The term necessary for tax purposes has a wider definition than that found in common usage

today.

As the tax cases illustrated above, the expense does not have to be "absolutely necessary"

in the sense that it is "indispensable" to carrying on the business.

It only needs to be helpful to one's business as well as appropriate for one's business.

Practical Example 19: Renting office space is certainly helpful to a tax preparer, providing a

place for the preparer to meet with clients and for employees to work. However, renting an office

is not necessary for a tax preparer to conduct his trade, since many sole proprietors, preparers

work out of their home, or provide their services at their clients' homes or businesses. In

addition, an office is very appropriate for a tax preparer, providing a workplace for him and his

employees.

The best advice the tax preparer can give a taxpayer regarding “ordinary and necessary”

expenses is good record keeping. All taxpayers should have records and receipts. There are many

ways a business taxpayer can keep and substantiate his or her records. Any recordkeeping system

suited to his or her business that clearly shows the income and expense is acceptable. The books

must show the gross income, as well as deductions and credits. For most small businesses, the

business checkbook is the main source for entries in the business books.43

Damage Awards

The taxation of damage awards continues to generate litigation. Damage awards fall under IRC

§104(a) (2). This year, at least ten taxpayers challenged the inclusion of settlement proceeds or

arbitration awards in gross income, and the IRS won every case. The code specifies that damage

awards and settlement proceeds are taxable as gross income unless the award was received “on

account of personal physical injury or physical sickness.44” Congress added the “physical injury

or physical sickness” requirement in 1996; until then, the word “physical” did not appear in the

statute.

43 IRS Publication 583 44 Pub. L. No. 104-188, § 1605(a), 110 Stat. 1755, 1838 (1996).

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A court cannot consider damage awards for emotional distress to be excludible from income,

even if the emotional distress has resulted in “insomnia, headaches, or stomach disorders.” To

justify exclusion from income under IRC §104, the taxpayer must show that settlement proceeds

are in lieu of damages for physical injury or sickness.

Settlements and judgments are taxed according to the item for which the plaintiff was seeking

recovery (the "origin of the claim"). If the taxpayer is suing a competing business for lost profits,

a settlement will be lost profits, taxed as ordinary income. A taxpayer laid off from work and

sues for discrimination seeking wages and severance, the wages are taxed as any other wages.

If the taxpayer sues for damage to their condominium by a negligent building contractor, the

damages usually will not be income. Instead, the recovery will be treated as an expense to repair

the condominium and/or affect the basis of the condominium.

Legal Fees: If the taxpayer settles a suit for intentional infliction of emotional distress against a

neighbor for $100,000 and the lawyer fee is $40,000. The $100,000 would be taxable and the

$40,000 would be an itemized deduction, subject to 2% of AGI.45

45 Tc 1997-312 eFleur v Commissioner

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What Do You Think?

Q1. The majority of gross income cases this year involved taxpayers failing to

report items of income, including some specifically mentioned in IRC §61 such

as wages, interest, dividends, and annuities. Which of the following is correct

regarding “trade or business” income?

.

A. The code does not define “trade or business income.

B. An activity conducted with “continuity and regularity” and with the

primary purpose of earning income or making profit.

C. Wages, interest, dividends, and annuities are part of gross income

according to IRC §61

D. Legal fees are considered part of the gross settlement for emotional distress.

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What Do You Think? - Answers

Answer Q1: D is the correct answer

Although “trade or business” is one of the most widely used terms in the IRC,

neither the Code nor the Treasury Regulations provide a definition. The

definition of a “trade or business” comes from common law, where the concepts

have been developed and refined by the courts. The Supreme Court has

interpreted “trade or business” for purposes of IRC §162 to mean an activity conducted with

“continuity and regularity” and with the primary purpose of earning income or making profit.

A court considers damage awards for emotional distress to be excludible from income

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Chapter Five - Identity Theft

The Dirty Dozen46 listing, compiled by the IRS each year, lists a variety of common scams

taxpayers can encounter at any point during the year. Many of these schemes peak during filing

season as people prepare their tax returns. It is important that tax preparers are aware of these

scams and can advise the taxpayers.

Topping the “Dirty Dozen” list is identity theft.

If the SSN is compromised or the taxpayer suspects they are a victim of tax-related identity theft,

they should take these additional steps:

Respond immediately to any IRS notice; call the number provided

Complete IRS Form 14039, Identity Theft Affidavit. Use a fillable form at IRS.gov, print,

then mail or fax according to instructions.

Continue to pay taxes and file the tax return, even if it must be filed on paper.

The IRS continues to aggressively pursue the criminals that file fraudulent returns using

someone else’s Social Security number. Though the agency is making progress on this front,

taxpayers still need to be extremely careful and do everything they can to avoid being victimized.

Preparers should follow up with their clients, be sure they have all the necessary information to

respond to the IRS and resolve the situation as soon as possible.

Efforts by the IRS

Launched in March 2015, the IRS started an initiative47 to address tax-related identity theft. It is

a partnership between the IRS, state tax administrators and the tax industry, including tax return

preparation firms, tax software vendors and payroll and tax financial product processors. The

goal is to establish safeguards to protect taxpayer information and the integrity of federal and

state tax systems.

The Taxpayer Advocate Service is a legitimate IRS organization that helps taxpayers resolve

federal tax issues that have not been resolved through the normal IRS channels. The IRS,

including TAS, does not initiate contact with taxpayers by email, texting or any social media.

TIGTA’s mandate is to provide independent oversight of the IRS in its administration of our

Nation’s tax system. Based on the increased number and sophistication of threats to taxpayer

information and the need for the IRS protect the taxpayer TIGTA will continue auditing and

investigating security issues at the IRS.

46“ Dirty Dozen” - IR-2016-12, Feb. 1, 2016 47 IR 2015-87

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The following items are some of the key parts of the IRS efforts:

Form W-2: Each filing season, the IRS receives millions of returns from individuals

requesting refunds based on wages and tax withholding reported on Forms W-2. Due to

the previously allowed filing dates of Form W-2 the IRS did not receive the Form W-2

information from the Social Security Administration (SSA) until well after the tax season

had begun. Identity thieves routinely exploit this gap by filing fraudulent refund claims

early in the filing season using false income documents from authentic employers.

The Protecting Americans from Tax Hikes Act (PATH) accelerated the due date for filing

Forms W-2 to January 31, effective for Forms W-2 filed in 2017 regarding wages paid in

2016. The new January 31 due date for Forms W-2 will make information available to the

IRS sooner,

Identification Protection PIN Program

An IP PIN is a six-digit number assigned to eligible taxpayers that helps prevent the

misuse of their Social Security number on fraudulent federal income tax returns. The

taxpayer cannot use an IP PIN as their e-file signature PIN.

A new identity theft victim assistance organization is managing the IP PIN program, the

IRS’s main tool for protecting taxpayers against ongoing identity theft. The IRS has

issued 1.5 million IP PINs and is offering the opportunity to opt into the IP PIN program

to approximately 1.7 million taxpayers whom the agency has identified as having been

potentially affected by identity theft.

For additional information go to http://www.irs.gov/Individuals/Identity-Protection

Fraud identification: The tax industry is now sharing information. The IRS and state tax

authorities are comparing information to detect fraud schemes in an attempt to stop them

before they take hold.

Identity theft data models and filters have been set up to identify potential fraudulent

returns. The IRS reported that hey rejected or suspended the processing 4.8 million

suspicious returns totaling 8 billion dollars in 201548.

Security requirements for software companies have been increased. These

requirements include passwords, security questions and lockout features, which will in

turn increase security at the IRS.

48 FS-2016-1

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SCAMS

A common scam is sophisticated phone scam targeting taxpayers, including recent immigrants,

throughout the country. Victims are told they owe money to the IRS and it must be paid

promptly through a pre-loaded debit card or wire transfer. If the victim refuses to cooperate, they

are then threatened with arrest, deportation or suspension of a business or driver’s license.

Characteristics of this scam include:

Scammers use fake names and IRS badge numbers. They generally use common names

and surnames to identify themselves.

Scammers may be able to recite the last four digits of a victim’s Social Security Number.

Scammers spoof the IRS toll-free number on caller ID to make it appear that it’s the IRS

calling.

Scammers sometimes send bogus IRS emails to some victims to support their bogus calls.

Victims hear background noise of other calls being conducted to mimic a call site.

After threatening victims with jail time or driver’s license revocation, scammers hang up

and others soon call back pretending to be from the local police or DMV, and the caller

ID supports their claim.

This scam should be reported to the Treasury Inspector General for Tax Administration at 1-800-

366-4484.

Letters from the IRS

Several clients have received Letter 4883c - This letter tells the taxpayer that the IRS needs more

information to verify their identity in order to process your tax return accurately. The contact

information below is only for taxpayers who received Letter 4883C. Be sure your clients follow

up on these letters.

The taxpayer who receives Letter 4883c should call the toll-free IRS Identity Verification

telephone number, 1-800-830-5084. Be sure they have a copy of their prior year tax return and

the most recently filed tax return. The toll-free IRS Identity Verification telephone number is

available for them to call even if you have not filed a tax return for this year.

Phone Scams: Phone calls from criminals impersonating IRS agents remain an ongoing threat to

taxpayers. The IRS has seen a surge of these phone scams in recent years as scam artists threaten

taxpayers with police arrest, deportation and license revocation, among other things.

Preparers should caution their clients not to give out any information over the phone, Be sure

you review with them that this is a scam. Police reports and reports to the IRS are being filed

daily. Older clients are very vulnerable to this and should be made aware.

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The following are five tips from the IRS on what they will not do, that can be passed to

taxpayers:

The IRS will never:

Call to demand immediate payment, nor will the agency call about taxes owed without

first having mailed a bill.

Demand that payment of taxes without giving the taxpayer the opportunity to question or

appeal the amount they owe.

Require the taxpayer to use a specific payment method for taxes, such as a prepaid debit

card.

Ask for credit or debit card numbers over the phone.

Threaten to bring in local police or other law-enforcement groups to have the taxpayer

arrested for not paying.

Phishing: A very common scam is the email phishing scam. Phishing is a scam typically carried

out with the help of unsolicited email or a fake website that poses as a legitimate site to lure in

potential victims and prompt them to provide valuable personal and financial information.

Armed with this information, a criminal can commit identity theft or financial theft. The emails

appear to be from the IRS Taxpayer Advocate Service and include a bogus case number and the

following message:

“Your reported 2015 income is flagged for review due to a document processing error.

Your case has been forwarded to the Taxpayer Advocate Service for resolution

assistance. To avoid delays processing your 2015 filing contact the Taxpayer Advocate

Service for resolution assistance.”

This email will contain links directing the taxpayer to a website to collect personal information;

taxpayers should not respond and should forward the email to the IRS at phishing@irs.gov.

Taxpayers need to be on guard against these fake emails or websites looking to steal personal

information. The IRS will never send taxpayers an email about a bill or refund unexpectedly. Do

not click on one claiming to be from the IRS. Be wary of strange emails and websites that may

be nothing more than scams to steal personal information.

Tax preparers should warn their clients that the IRS does not email personal data and this is a

scam.

An example of phishing was investigated by the Treasury Inspector General for Tax

Administration (TIGTA) in which several individuals were deceived into providing their

personal identification numbers and banking information to identity thieves who then defrauded

them of over $1 million. The phishing scheme was designed to defraud numerous individuals

through Internet solicitations and stealing the identities of those individuals. The subject of the

investigation was sentenced to a total of 30 months of imprisonment and five years of supervised

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release for aggravated identity theft and conspiracy to commit wire fraud. He was also ordered to

pay $1,741,822 in restitution to his victims49

If the taxpayer receives an unsolicited email that appears to be from either the IRS or an

organization closely linked to the IRS, such as the Electronic Federal Tax Payment System

(EFTPS), report it by forwarding the email to phishing@irs.gov.

Another scam affects tax professionals, a website that mimics the IRS e-Services online

registration page. The phony web page looks almost identical to the real one. The IRS gets many

reports of fake websites like this. Criminals use these sites to lure people into providing personal

and financial information that may be used to steal the victim’s money or identity. Typically,

identity thieves empty the victim’s financial accounts, run up charges on the victim’s existing

credit cards or apply for new loans, credit cards, services or benefits in the victim’s name.

NOTE: The address of the official IRS website is www.irs.gov. Do not be misled by sites

claiming to be the IRS but ending in .com, .net, .org or other designations instead of .gov. The

IRS website has information that can help tax professionals and taxpayers protect themselves

from tax scams of all kinds. Search the site using the term: phishing

It is important to keep in mind the IRS does not initiate contact with taxpayers by email to

request personal or financial information. This includes any type of electronic communication,

such as text messages and social media channels.

Letters received from the IRS regarding phishing: Eric and Kathy James were

gathering their tax documents before they went for their tax appointment when they

received Letter 5071C from the IRS. The James immediately contacted their tax preparer

office. Not being familiar with this particular letter, the tax preparer immediately went to

the IRS website to confirm this letter as authentic and not a phishing document.

Once the document was authenticated, the clients followed the directions on the letter.

They attempted to call the number on the letter for the identity verification, unfortunately,

with the IRS budget cuts the recording told them to go to the website and verify their

identity. The James went to their tax preparer office who helped them verify their

identity. The instructions after their identity was established was to file a paper return and

send it to the address on the letter. All paper returns take longer to process. The James

sent their return with a “receipt of mailing”, since they owed money they have been

checking their bank for the cancelled check and are keeping all their documents for any

future correspondence with the IRS.

Rejected e-file. An electronic return is rejected because the SSN belonging to the

taxpayer, spouse or dependent has been used on another return for that year.

49 E.D.N.Y. Response to Defendant’s Sentencing Letter filed Dec. 19, 2011; E.D.N.Y. Judgment filed Aug. 9, 2012

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Ethics

To complete the paper return filing, the James completed Form 14039, Identity Theft

Affidavit, and attached a clear and legible copy of their passports. This form was attached

to their paper return.

The IRS instructions for Form 14039 allows any of the following for identification

purposes:

• Passport;

• Driver’s license;

• Social security card; or

• Other valid U.S. Federal or State government issued identification.

If your client is a victim of tax-related identity theft these publications are available.

Taxpayer Guide to Identity Theft

Publication 5027, Identity Theft Information for Taxpayers (PDF)

Data Breach: Tax-Related Information

Requesting Copy of Fraudulent Return

Publication 4524, Security Awareness For Taxpayers (PDF)

Identity Theft Victim Assistance: How It Works

Information for Tax Preparers

Identity Theft Information for Tax Preparers

Publication 5199, Tax Preparer Guide to Identity Theft (PDF)

Information for businesses about data breaches and identity theft

Tax Practitioner Guide to Business Identity Theft

Federal Trade Commission Publications

Taking Charge – What to Do If Your Identity is Stolen?

Safeguarding – Your Child’s Future

https://bulkorder.ftc.gov/publications?f%5B0%5D=field_campaigns%3A1587

The IRS recommends the following Steps to take as a victim50:

File a report with law enforcement.

Report identity theft at ftc.gov/complaint and learn how to respond to it at

identitytheft.gov.

Contact one of the three major credit bureaus to place a ‘fraud alert’ on credit records:

o Equifax, www.Equifax.com, 1-800-525-6285

o Experian, www.Experian.com, 1-888-397-3742

o TransUnion, www.TransUnion.com, 1-800-680-7289

Contact the financial institutions, and close any accounts opened without permission or

tampered with.

50 IRS Pub. 4535, Identity Theft Protection and Victim Assistance

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Ethics

Check with the Social Security Administration earnings statement annually. An account Victim

of identity theft not concerning the tax return. The taxpayer should follow the steps above that

the IRS recommends. In addition, contact should be made with the Identity Protection

Specialized Unit of the IRS. 1-800-908-4490

Return Preparer Fraud

About 60 percent of taxpayers will use tax professionals this year to prepare and file their tax

returns. Most return preparers provide honest service to their clients. However, as in any other

business, also some prey on unsuspecting taxpayers.

The following are some of items the Tax Division of the Department of Justice routinely identify

a fraudulent:

Preparing phony tax-return forms with fabricated businesses and income;

False education and homebuyer credits;

False and inflated deductions;

False filing status;

False dependents;

Selling deceptive loan products;

Filing tax returns without customer consent or authorization;

Preparing bogus W-2 forms, based on information from employee paystubs;

Falsifying information on returns to claim inflated earned income tax credits; and

Filing fraudulent tax returns using stolen taxpayer identities to obtain improper tax

refunds.

Some preparers try to conceal their fraud by not signing the returns they prepare and by using

stolen or fake social security numbers or PTIN to misidentify the paid preparer.

Taxpayers should know every paid preparer needs to have a Preparer Tax Identification Number

(PTIN) and enter it on the returns he or she prepares.

False Form 1099 Refund Claims

In this ongoing scam, the perpetrator files a fake information return, such as a Form 1099

Original Issue Discount (OID), to justify a false refund claim on a corresponding tax return. In

some cases, individuals have made refund claims based on the bogus theory that the federal

government maintains secret accounts for U.S. citizens and that taxpayers can gain access to the

accounts by issuing 1099-OID forms to the IRS.

Tax Fraud Case using 1099-OID51

Karen A. Olson admitted she participated in a conspiracy that promoted a tax refund scheme

across the United States from July 1, 2008, to Sept. 21, 2011. Conspirators received more than

$3.5 million of the total $96 million in attempted fraudulent refunds.

51justice.gov/usao/mow/divisions/OIDfraud.html

35

Ethics

Olson, who has an associate’s degree in accounting, was formerly employed as a tax preparer

and did taxes for people on the Air Force base where her husband was deployed while serving in

the military. On Oct. 13, 2008, the Olsons submitted a 2007 joint income tax return, including

fraudulent Forms 1099-OID. They received a refund of $171,806.

In actuality, Olson admitted that they had never accrued any OID income from the banks and

lenders listed on their Forms 1099-OID, nor had those entities issued the forms, nor had they

paid any taxes on the Olsons’ behalf.

People around the Olsons knew they had received a large refund from the process and began

asking them for their help. They decided to charge $200 per person or couple to transmit their

Forms 1099-OID and 1099-A through their tax preparation and submission company, FATR,

LLC. The Olsons assisted approximately 10 individuals/couples in preparing their Forms 1040

using the 1099-OID process. Four returns that were based on fraudulent Forms 1099-OID

claimed refunds totaling $825,907. Refunds totaling $408,693 were issued.

Under federal statutes, Olson is subject to a sentence of up to 10 years in federal prison without

parole, plus a fine up to $250,000 and an order of restitution.

Tax Fraud Case52

A Montclair CA man, who was charged for his role in a scheme to unlawfully use the names and

social security numbers of other people to file fraudulent federal income tax returns, has pleaded

guilty to tax and identity theft charges.

Specifically, Chibueze Chidozie Nwafor pleaded guilty to three criminal counts – presenting

false claims to the United States, theft of government benefits, and aggravated identity theft.

The charges are the result of an investigation by the IRS Criminal Investigation.

Nwafor used the identification of other individuals whom he knew to be real people, specifically

the names and social security numbers of purported tax filers, in order to submit false tax returns.

Nwafor knew the information contained in the false tax returns that he filed contained materially

false information, including taxes withheld and wages received from a bogus corporation,

California Mutual Life and Health (“CMLH”). Nwafor also misappropriated tax filer refunds to

which he was not entitled for his own use.

In 2009, Nwafor prepared tax returns for various individuals including a 2008 federal income tax

return in the name of an unidentified victim claiming a tax refund of $7,773, which included

Form W-2, which falsely claimed that the unidentified victim received $30,119 in wages from

CMLH. The IRS issued a tax refund, which Nwafor stole and converted to his own use.

For the 2010 tax year, Nwafor filed a fraudulent tax return on his own behalf claiming false

deductions, which resulted in Nwafor receiving a refund check in the amount of $32,789 from

52 USA v Chibueze Chidozie Nwafor

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Ethics

the IRS. It is estimated that the attempted tax loss attributable to Nwafor from 2009 through

2011 is approximately $126,991.

Because of the guilty plea, Nwafor faces a sentence of 70 months in federal prison and was

ordered to pay $118,474 in restitution to the IRS.

Hiding Income Offshore

Over the years, numerous individuals have been identified as evading U.S. taxes by hiding

income in offshore banks, brokerage accounts or nominee entities, using debit cards, credit cards

or wire transfers to access the funds. Others have employed foreign trusts, employee-leasing

schemes, private annuities or insurance plans for the same purpose.

The IRS uses information gained from its investigations to pursue taxpayers with undeclared

accounts, as well as the banks and bankers suspected of helping clients hide their assets overseas.

The IRS works closely with the Department of Justice to prosecute tax evasion cases.

While there are legitimate reasons for maintaining financial accounts abroad, there are reporting

requirements that need to be fulfilled. U.S. taxpayers who maintain such accounts and who do

not comply with reporting and disclosure requirements are breaking the law and risk significant

penalties and fines, as well as the possibility of criminal prosecution.

The IRS is in the middle of a major offensive against wealthy taxpayers who are hiding income

overseas to avoid taxes. An estimated 19,000 American citizens were hiding taxable assets in the

Swiss Bank UBS with the encouragement and assistance of the bank itself, the government

alleges. UBS is now cooperating and has paid a $780 million fine to avoid prosecution.

Bradley Birkenfeld, an American citizen who worked at UBS, voluntarily disclosed UBS

documents that alerted the U.S. to a scheme "to defraud the United States by impeding the IRS,"

the Department of Justice alleges. Department of Justice went on to say that Swiss bankers made

about 3,800 trips to the U.S. "to market Swiss bank secrecy to United States clients interested in

attempting to evade United States income taxes."

That prompted the IRS to establish a new unit, Offshore Voluntary Disclosure Program, which

allows the IRS to take a unified look at the entire web of business and economic entities

controlled by high-wealth individuals. Finding the missing income was made easier when UBS

agreed to turn over the names of U.S. citizens who have assets at the bank.

The IRS offered amnesty for those who came forward voluntarily, and so far, about 15,000

Americans have done so to avoid prosecution.

IRS compliance efforts have increased significantly regarding the reporting of foreign bank and

financial accounts. (FBAR)

California attorney Christopher M. Rusch was sentenced to 10 months in prison for helping his

clients Stephen M. Kerr and Michael Quiel hide millions of dollars in secret offshore bank

accounts. Rusch pleaded guilty on Feb. 6, 2013, to conspiracy to defraud the government and

failing to file a Report of Foreign Bank and Financial Accounts (FBAR)

37

Ethics

“Free Money” from the IRS & Tax Scams Involving Social Security

Flyers and advertisements for free money from the IRS, suggesting that the taxpayer can file a

tax return with little or no documentation, have been appearing in community churches around

the country. These schemes are also often spread by word of mouth as unsuspecting and well-

intentioned people tell their friends and relatives.

Scammers prey on low-income individuals and the elderly. They build false hopes and charge

people good money for bad advice. In the end, the victims discover their claims are rejected.

Meanwhile, the promoters are long gone. The IRS warns all taxpayers to remain vigilant.

There are a number of tax scams involving Social Security. For example, scammers have been

known to lure the unsuspecting with promises of non-existent Social Security refunds or rebates.

In another situation, a taxpayer may really be due a credit or refund but uses inflated information

to complete the return.

A common tax fraud against the elderly is convincing a Social Security Recipient who has no

other income, that they can receive a refund by filing a tax return; the scammer then receives the

Social Security Number of the recipient and prepares a fraudulent return.

False/Inflated Income and Expenses

Including income that was never earned, either as wages or as self-employment income in order

to maximize refundable credits, is another popular scam. Claiming income, the taxpayer did not

earn or expenses the taxpayer did not pay in order to secure larger refundable credits such as the

Earned Income Tax Credit could have serious repercussions. This could result in repaying the

erroneous refunds, including interest and penalties, and in some cases, even prosecution.

Additionally, some taxpayers are filing excessive claims for the fuel tax credit. Farmers and

other taxpayers who use fuel for off-highway business purposes may be eligible for the fuel tax

credit. However, other individuals have claimed the tax credit when their occupations or income

levels make the claims unreasonable. Fraud involving the fuel tax credit is considered a frivolous

tax claim and can result in a penalty of $5,000.

Tax Fraud Case against Preparer Kenneth L. Barber

Kenneth L. Barber has been convicted by a federal jury of wire fraud, preparing false returns,

making a false statement to a bank and conspiracy to commit tax fraud. At trial, the government

presented evidence that Barber ran and operated a local tax preparation business where he

encouraged preparers to falsify clients’ returns.

Government agents testified that the scheme resulted in a loss of more than $700,000. Barber

was also convicted of making false statements to a financial institution based upon evidence that

he provided a bank with false information concerning his income in order to qualify for loans

totaling more than $300,000.

38

Ethics

Records introduced at trial showed that personal and corporate returns he submitted to Wachovia

Bank reflected substantially greater income than the returns the defendant filed with the IRS.

Barber faces a maximum of five years in prison for conspiracy, three years in prison on each

count of preparing fraudulent returns, 20 years in prison on each count of wire fraud and 30 years

in prison on each count of making a false statement to a bank.

Frivolous Arguments

Promoters of frivolous schemes encourage taxpayers to make unreasonable and outlandish

claims to avoid paying the taxes they owe. The IRS has a list of frivolous tax arguments that

taxpayers should avoid. These arguments are false and have been thrown out of court. While

taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the

law.

One of the most common frivolous arguments is that the tax system is voluntary and it is up to

the taxpayer whether to file a return.

The word “voluntary,” as used by the IRS, refers to the system of allowing taxpayers initially to

determine the correct amount of tax and complete the appropriate returns, rather than have the

government determine tax for them from the outset. The requirement to file an income tax return

is not voluntary and is clearly set forth in IRC §§6011(a), 6012(a), and 6072(a)53

In United States v. Tedder54, the court stated that, “Although Treasury regulations establish

voluntary compliance as the general method of income tax collection; Congress gave the

Secretary of the Treasury the power to enforce the income tax laws through involuntary

collection. The IRS’ efforts to obtain compliance with the tax laws are entirely proper.”

Falsely Claiming Zero Wages

Filing a phony information return is an illegal way to lower the amount of taxes an individual

owes. Typically, a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 is used as a

way to improperly reduce taxable income to zero. The taxpayer may also submit a statement

rebutting wages and taxes reported by a payer to the IRS.

Sometimes, fraudsters even include an explanation on their Form 4852 that cites statutory

language on the definition of wages or may include some reference to a paying company that

refuses to issue a corrected Form W-2 for fear of IRS retaliation. Taxpayers should resist any

temptation to participate in any variations of this scheme. Filing this type of return may result in

a $5,000 penalty.

NOTE: Tax preparers fraudulently use Line 21 of Form 1040 to subtract the income shown on a

W-2, as well as using Miscellaneous Deductions on Schedule A.

53 Reg. § 1.6011-1(a) 54 Case 787 F.2d 540, 542 (10th Cir. 1986),

39

Ethics

Abuse of Charitable Organizations and Deductions

IRS examiners continue to uncover the intentional abuse of 501(c)(3) organizations, including

arrangements that improperly shield income or assets from taxation and attempts by donors to

maintain control over donated assets or the income from donated property. The IRS is

investigating schemes that involve the donation of non-cash assets –– including situations in

which several organizations claim the full value of the same non-cash contribution. Often these

donations are highly overvalued or the organization receiving the donation promises that the

donor can repurchase the items later at a price set by the donor. The Pension Protection Act of

2006 imposed increased penalties for inaccurate appraisals and set new standards for qualified

appraisals.

Subject to certain limitations, taxpayers can take a deduction from their adjusted gross income

for contributions of cash or other property to charitable organizations.55 Taxpayers must

contribute to certain qualifying organizations,56 and are required to substantiate contributions of

$250 or more. Litigation generally arises over one of four issues:

1. Whether the organization receiving the contribution is charitable in nature;

2. Whether the property contributed qualifies as a charitable contribution;

3. Whether the amount deducted equals the fair market value of the property contributed;

and

4. The extent to which the taxpayer has substantiated the contribution.

Taxpayers can generally take a deduction for charitable contributions made within the taxable

year.57 For individuals, these deductions are generally limited to 50 percent of the taxpayer’s

contribution base (adjusted gross income computed without regard to any net operating loss

carryback to the taxable year under IRC §172). However, subject to certain limitations,

individual taxpayers can carry forward unused charitable contributions in excess of the 50

percent base for up to five years. Corporate charitable deductions are generally limited to ten

percent of the taxpayer’s taxable income. Taxpayers cannot deduct services that they offer to

charitable organizations; however, incidental expenditures incurred while serving a charitable

organization and not reimbursed may constitute a deductible contribution58.

Deductions for charitable contributions of $250 or more are disallowed in the absence of a

contemporaneous written receipt from the recipient. For cash contributions, taxpayers must

maintain receipts from the charitable organization, copies of canceled checks, or other reliable

records showing the name of the organization, the date, and the amount contributed. For each

contribution of property other than money, taxpayers generally must maintain a receipt showing

the name of the recipient, the date and location of the contribution, and a description of the

property. When property other than money is contributed, the amount of the allowable deduction

is the fair market value of the property at the time of the contribution.59

55 IRC §170 56 IRC § 170(c)(2). 57 IRC § 170(a)(1). 58 Treas. Reg. § 1.170A-1(g). Meal expenditures in conjunction with offering services to qualifying organizations

are not deductible unless the expenditures are away from the taxpayer’s home. IRC § 170(j). 59 Treas. Reg. § 1.170A-13

40

Ethics

What Do You Think?

Q1. Which of the following is not an action the IRS has under taken to combat

identity theft?

A. A requirement for employers to file W-2s by January 31.

B. Phone call to taxpayers to verify their tax information submitted

C. Adjustments of data filters to prevent identity theft and fraudulent

returns.

D. Taxpayer awareness.

Q2. Which of the following is correct regarding deductions for charitable contributions of $250

or more?

A. The deductions are disallowed in the absence of a contemporaneous written receipt from

the recipient.

B. Cash contributions must have receipts from the charitable organization.

C. The amount of the allowable deduction is the fair market value of the property at the time

of the contribution.

D. All of the above are correct

41

Ethics

What Do You Think? - Answers

Answer Q2: D all the statements are correct

Deductions for charitable contributions of $250 or more are disallowed in the

absence of a contemporaneous written receipt from the recipient. For cash contributions,

taxpayers must maintain receipts from the charitable organization, copies of canceled checks, or

other reliable records showing the name of the organization, the date, and the amount

contributed. For each contribution of property other than money, taxpayers generally must

maintain a receipt showing the name of the recipient, the date and location of the contribution,

and a description of the property. When property other than money is contributed, the amount of

the allowable deduction is the fair market value of the property at the time of the contribution.60

Answer Q2:B is the correct answer.

The IRS will not call to verify information; they do this through employer filing and data

models. If the IRS needs additional information, they will generate a letter,

The IRS will never:

Call to demand immediate payment, nor will the agency call about taxes owed without

first having mailed a bill.

Demand that payment of taxes without giving the taxpayer the opportunity to question or

appeal the amount they owe.

Require the taxpayer to use a specific payment method for taxes, such as a prepaid debit

card.

Ask for credit or debit card numbers over the phone.

Threaten to bring in local police or other law-enforcement groups to have the taxpayer

arrested for not paying.

60 Treas. Reg. § 1.170A-13

2016

TaxEase, LLC

2 HOUR ETHICS

EXAM QUESTIONS

ETHICS

Final Exam - Ethics

1. The tax preparer realizes that income was not reported on a client’s current year tax

return which had already been electronically filed and accepted by the IRS. Which of the

following statements reflect the appropriate action the tax preparer should take?

A. The preparer should notify the taxpayer at once and explain that he or she should

amend their return immediately because he or she is required to report all income

in the year received, and so he or she can avoid additional penalties and interest.

B. The preparer should contact the IRS immediately and report the omission of

income.

C. The preparer should tell the taxpayer to wait until the IRS sends them a CP2000

requesting the additional tax be paid.

D. The preparer should ignore the situation in hopes it will go away.

2. A tax preparer takes on a new client who had his 2014 tax return prepared by a different

preparer. The taxpayer requested the preparer review his 2014 return in hopes of

amending the return and receiving a larger refund. While reviewing the return the

preparer finds that a 1099-Misc, Box 3 (Other income) in the amount of $900 had not

been reported on the return. Which answer is correct on how the preparer should handle

this situation?

A. Since the preparer did not prepare or sign the 2014 return he or she is not under

any obligation to address the issue.

B. The tax preparer should discuss with the taxpayer that he or she should amend

their 2014 return because they are required to report all income in the year it is

received. The preparer should offer to amend the 2014 and prepare the 2015

return for the taxpayer or suggest that the taxpayer go back to the original

preparer and ask him or her to amend the return.

C. The preparer should instruct the taxpayer to report this income on their 2015 tax

return.

D. The preparer should only tell the taxpayer that he or she does not have an

additional refund coming their way from 2014.

3. The voluntary Annual Filing Season Program is intended to recognize and encourage

unenrolled tax return preparers who voluntarily increase their knowledge and improve

their filing season competency through continuing education. Which of the following are

not correct?

A. An unenrolled or unlicensed tax preparer may represent a tax client only if they

successfully complete the AFSP course

B. All tax professionals who receive payment for preparation of a tax return must

have a PTIN.

C. Enrolled Agents must complete the AFSP program to preparer tax returns for

payment.

D. All of the statements above are correct.

4. In reference to the term “due diligence”. The following statements are correct; except

A. A tax professional has specific and well defined rules to follow compared to other

professionals in other fields in order to meet their due diligence requirement.

B. A tax preparer may be judged to have met their due diligence if he or she applied

the same level of intenseness and care in preparation of the return as other tax

professionals would deem appropriate.

C. Reasonable inquiries of the taxpayers presented documentation will assist the tax

preparer in meeting his or her due diligent requirement.

D. All the statements above are correct

5. Which of the following statements is correct?

A. It does not matter in what order the consent information is arranged on the

consent to disclose or use form as long as a preparer includes all the required

information.

B. The same exact wording can be used for both the consent to disclose and the

consent to use form.

C. The consent to disclose is not needed if a client asks their tax preparer to discuss

his or her tax return with his or her attorney.

D. None of the above statements are correct

6. In reference to the disclosure or use of taxpayer’s tax return information. Which of the

following statements is a correct statement?

A. The criminal penalty for knowingly and recklessly disclosing a taxpayer’s return

information is a maximum $1,000 fine or the maximum imprisonment of no more

than one year, or both.

B. The civil penalty for unauthorized disclosure or use of a taxpayer’s information is

$250 for each disclosure or use not to exceed $10,000 for a calendar year.

C. Both A and B are correct

D. Neither A or B are correct

7. The following are true statements; except?

A. If a taxpayer gives his or her tax preparer a check made payable to the

Department of Treasury for a tax payment that they owe, the tax preparer must

immediately remit the check to the designated agency.

B. A tax preparer who disagrees with an IRS agent can withhold the information the

agent is requesting without consequence.

C. A tax preparer who is required by the IRS to electronically file the tax returns that

they prepare, fails to do so, may face an incompetence and disreputable conduct

violation.

D. A preparer may not knowingly assist another tax preparer in tax preparation

during his or her colleague’s suspension from preparing tax returns.

8. Which of the following is not correct regarding “competent practice” of Circular 230,

Section 10.35?

A. An unenrolled preparer does not have to regard Section 10.35.

B. A preparer must possess necessary competence to engage in practice before the

Internal Revenue Service.

C. A preparer is required to have the appropriate level of knowledge for tax

preparation.

D. Competent practice, skill, thoroughness, and preparation necessary for the matter

for which the practitioner is engaged is required.

9. What does the “voluntary” tax system mean as used by the IRS?

A. An individual can choose to file a tax return.

B. Allows taxpayers to initially determine the correct amount of tax and complete the

appropriate returns.

C. The Secretary of the Treasury has the power to enforce the tax laws through

voluntary collection. above are relevant.

D. None of the above define voluntary tax system.

10. Which of the following is considered fraudulent by a tax preparer?

A. Preparing a return without entering a PTIN

B. Filing a return knowing the filing status is incorrect

C. Filing tax returns without customer consent or authorization

D. All of the above are considered fraudulent actions by the preparer.

Ethics

A B C D

1 A B C D

2 A B C D

3 A B C D

4 A B C D

5 A B C D

6 A B C D

7 A B C D

8 A B C D

9 A B C D

10 A B C D

Name: ___________________________

Date: ____________________________

TaxEase, LLC

Answer Sheet 2016– 2 Hour Ethics CE

Answer Sheet Instructions

Using ink mark an X in the column which

reflects the correct answer.

Example: Question 1 – How many inches are

in a foot?

A. 9 B. 6 C. 3 D. 12

Question A B C D

1 A B C X

2 A B C D

3 A B C D

PERSONAL INFORMATION FORM

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Be sure that your name and the date of submission are on the answer sheet.

Complete the Personal Information Form above and the Evaluation Form

EMAIL or FAX the Answer Sheet, Personal Information Form, and Evaluation Form to:

Email – support@taxeaseed.com Fax – (510) 779-5251

*Required Information: All required information must be completed in order for TaxEase to grade the exam.

TAXEASE REPORTS EDUCATION TO CTEC. IT IS

THE STUDENT’S RESPONSIBILITY TO COMPLETE

THEIR REGISTRATION RENEWAL WITH CTEC

ANNUALLY.

THE IRS REQUIRES THAT TAXEASE REPORT

THE STUDENTS CONTINUING EDUCATION

TO THE IRS IF THE STUDENT PROVIDES US

WITH THEIR PTIN.

2016 Continuing Education Student Course Evaluation

TaxEase LLC

IRS Issued Course Numbers: 2 Hour Ethics B8FQK-E- 00017-16-S

CTEC Issued Course Number: 3064-CE-0037

Student’s Name: ____________________________ Date: ___________________

Ethics

Date Program Completed

Hours Spent to Complete

Instructions: Please comment on all the following evaluation points on the programs and

assign a number grade, using 1-5 scale, with 5 being the highest.

Ethics

Were the stated learning objectives met?

Were the course materials accurate and relevant,

and did they contribute to the achievement of the

learning objectives?

Was the time allocated to learning adequate?

Was the course syllabus satisfactory?

Part of the course you found most beneficial:

Part of the course you found least beneficial:

Additional Comments:

Please return with your completed answer sheet