Friday, October 23, 2009


In Part I of this post I occasionally used the phrase “unless I have direct personal knowledge to the contrary”. What do I mean by this?

Let us say that a client has filled out one of my worksheets stating that the rent collected for the year on the upstairs apartment of a two-family house is $9,600 – or $800 per month. But, when talking to the client he mentions to me that the rent he gets from the tenant is actually $1,050 per month. I now have “direct personal knowledge to the contrary”.

Or perhaps I have a client who does occasional carpentry on the side and gives me a sheet of paper listing his income and expenses that shows $3,500 as total gross receipts for the year. However, in July of the tax year in question I had paid the client $4,000 to install new kitchen cabinets in my home. I have “direct personal knowledge to the contrary” that the client’s gross income for the year was at least $4,000. (To be fair, the client may have split the work with another part-time carpenter, giving him $1,000 for his labor, and is claiming on his worksheet only his share of the fee and not deducting out the $1,000 paid to the other carpenter in his list of itemized expenses – but I must ask the client to find this out.)

And a third possibility – I have a client who each year only reports, to me and to the IRS and NJDOT, income from his W-2 job and some interest and dividends from 1099s. I have another client who had work done on his rental property during the year. Included in the cancelled checks for the repairs that this client shows me is one to the first client for $600 for painting the apartment. The second client tells me that the first client is a self-employed painter on the week-ends. I now have “direct personal knowledge to the contrary” that the client has additional, unreported, taxable income.

In each of these cases I must tell the client that I have “direct personal knowledge to the contrary” and that if he wants me to prepare his tax return I must report the correct amount of income.

Now if one client just happens in passing to mention that another client does not report all his income, but the “complaining” client has no first-hand knowledge of the truthfulness of this statement and is just making a guess based on what he thinks may be true, this is pure hearsay and definitely not “direct personal knowledge to the contrary”. In my opinion I am not even obligated to ask the other client about this contention.

While the Internal Revenue Service considers the tax preparation community as a “stakeholder”, as a tax preparer I am not in any way a representative or agent of the Internal Revenue Service or any state tax authority.

My only obligations and responsibilities to the IRS or a state are, as stated in Part I, “to report all taxable income and claim all allowable deductions and credits, as identified in the Internal Revenue Code, of which I have knowledge, in a manner that is prescribed or allowed by the Tax Code or IRS and state rules and regulations” – basically to prepare an accurate and honest return - and to comply with the standards required of all tax preparers, unenrolled and otherwise, outlined in IRS Publication 470 and IRS Circular 230.

While, as previously mentioned, I am not obligated or required to personally verify all numbers entered on the 1040 (or 1040A), I am required to do what is called “due diligence” when it comes to information provided by the client. What this means is that I must -

• evaluate information received from clients,
• apply a consistency and reasonableness standard to the information, and
• ask additional questions if the information appears incorrect, inconsistent or incomplete.

Obviously, if a client says or indicates something that does not make sense, or does not seem reasonable, I must ask questions. And if a new client comes in who drives the latest model Mercedes Benz, is wearing a $500 suit and a $5,000 Rolex, and lives in a $1 Million + house, but claims only $50,000 in income for the year, I must dig deeper.

But if what a client tells me, or indicates on a worksheet, appears to me to be reasonable considering the individual facts and circumstances than I do not need to go any further.

When it comes to the Earned Income Credit I am required to be a bit more “due” in my “diligence”. As a side comment, I do not think it is fair for the IRS to require tax preparers to determine if an individual is eligible for federal welfare (which, after all, is what the EIC is).

I must sign all returns that I have prepared for a fee.

I cannot endorse or negotiate a client’s refund check.

I must not charge an “unconscionable” fee (are CPAs and Henry and Richard aware of this?).

If I take a position on a tax return that is excessively controversial, one that may be contrary to regulation, I must attach to the return a schedule or statement disclosing the controversial position taken.

As a “financial professional” it appears I am also required to disclose to clients my “Privacy Policy”, which is -

I collect nonpublic personal information about you from (1) information I receive from you on work-sheets and other documents that I use in preparing your tax return, and (2) information about your transactions with me or with others.

I do not disclose any nonpublic personal information about you to anyone, except as permitted by law.

If you decide to close your account or become an inactive client, I will adhere to the privacy policy as described in this notice.

I am the only person with access to your personal and account information. I maintain physical, electronic and procedural safeguards that comply with federal standards to guard your information

Finally, as a member of the National Association of Tax Professionals I am obligated to comply with the Association’s “Standards of Professional Conduct”. The purpose of these standards is to establish a threefold responsibility of members –

Our first responsibility is to our clients. Members should make every effort to protect the interests of the client and advise the client when the client is taking the wrong course of conduct. The client is responsible for any decisions made when the tax return is prepared. When the client signs the tax return, it has the force of an affidavit.

The second responsibility is to the member himself. Members should conduct their practice so that it will not jeopardize their professional reputation or self-respect. The member should not be unreasonable in requiring proof of statements made by the taxpayer.

The third responsibility is to the government. In this respect, a member should always bear in mind the member is governed by the law, regulations, and decisions that make up their field of tax practice

The document goes on to list specific examples of standards of ethical conduct, similar to those imposed by the Internal Revenue Service.

Before I end - What about the client?

A 1040 client also has obligations, responsibilities and requirements regarding the return. In the letter that I give to clients with their finished returns I state –

There returns are subject to review and examination by the IRS and appropriate state tax agencies. We accept responsibility for the clerical and mathematical accuracy of all returns I have prepared. However, the burden of proving the facts reported on your tax return rests with you. You are responsible for keeping all of the necessary documentation of the income and deductions claimed on these returns for at least three (3) years.”

This letter also says –

Please examine these returns carefully to be sure all items of income and deductions have been accounted for properly. You are responsible for all the information reported on the returns. If you find anything that is not in order, or that you do not understand, contact us immediately. It is extremely important that you verify the accuracy of all Social Security numbers on the returns before mailing.”

As the NATP Standards of Professional Conduct quoted above says – “The client is responsible for any decisions made when the tax return is prepared. When the client signs the tax return, it has the force of an affidavit.”

Bottom line - you should not take the finished returns from me, or your tax professional, and just sign and mail without actually looking at them. You should carefully review all the forms and schedules that make up the returns before you sign and send.


PS – Now your comments are welcome and solicited!


Bruce said...

Well-written and true to fact/s. With are not just “your” obligations, but mine and every other tax preparer out here.

Engagements are a key to all of this. I and many others I am aware have engagement letters I have clients new and repeat clients sign these every year. In these I explain my “role” and their “role” in what I am about to do.

My friend I find in your writings that you and I have much in common. I commend you on your personalized questionnaire for your clients. I use one that I have made but it is general in all facts very generic. This year I have purchased a questionnaire with accompanying worksheets for Sch C clients, E client, D clients etc.

I’ll let you know how that goes.

As you say “my basic obligation and responsibility, is to my practice, my client, the IRS and state authorities. To report all taxable income and claim all allowable deductions and credits, as identified in the Internal Revenue Code, of which I have knowledge, in a manner that is prescribed or allowed by the Tax Code or IRS and state rules and regulations.” In those regulations all information must be accurate to the best of my knowledge.

With your permission, I may use part of your client letters as I have used your information of worksheets you made available last year for all to purchase if so desired. They came in very helpful.

I often inquiry of my clients about their numbers. Those with biz returns and rentals are usually to some question. In my quarry, I ask to see ledgers if possible. I do this in an effort to assure not only for my knowing where they arrived their numbers, but for the clients well being, meaning if I see in a ledger that a framing contractor purchased lingerie as a business expense, I would question him/her on this. Basically, I am covering my client, in a manner that should their return be looked at, I know, and they’ll know everything is above board. And an audit is just a paper trail of accuracy. This in all is part of my “due diligence”

I am grateful for the rules set forth in the above mentioned IRS publications. As for fees, I list them openly on my web site, as I also mention in the same location I only charge for what I do. Meaning if I have a form that is normally $35, I enter one number on it, I won’t charge the whole amount. I have a base that I feel each client must pay to cover cost of supplies, as my office is in my home, that is the extent on my overhead.

I take the responsibilities set by NATP very seriously, with heavy emphasis on my clients’ best interest.

My mission, why I do what I do, is to help taxpayers with the preparation of their 1040’s.

Anonymous said...

Here's an interesting ethical conundrum for you.

Taxpayer Mr. and Mrs. John Doe come to file their tax return and they claim their 22 year old college student daughter Julie as their dependent on their tax return. Julie lived with them all year and attended the spring semester as a full-time student at the local college and then worked for the rest of the year at a minimum wage job. Julie made about $12K from that job and had no other income. They show you the 1098-T and the burser's statement, and they have cancelled checks showing they paid her $20,000 tuition for the spring semester, which runs from January through May. Since they also provided housing and groceries for the whole year, you file their joint return, claiming Julie as their qualifying child dependent. You also tell them Julie should file a return herself, based on the facts they've shared.

A month later, Julie comes in to see you. Upon close questioning, you learn that Julie actually stopped attending her classes in April, but never told her parents that she had stopped going to the classes her parents were paying for. Based on her actual class attendance, the IRS considers that she was only a full-time student during four months of the year. Based on the facts above, she does not qualify as her parents' dependent. In fact, she is eligible to claim her own personal exemption AND she is eligible to claim the tuition tax credit (even though her parents paid it!)

Julie doesn't want to tell her parents that she stopped attending classes in April.

What is your ethical obligation to her parents, whose return you have already prepared and they have mailed in?

What is your ethical obligation to Julie to preserve the confidentiality of the information she has given you about her class attendance?

(One can devise other variations on this scenario in which a dependent has much more income than they told their parents about, possibly from a source their parents would not approve of--e.g., working as a stripper, selling illegal drugs, etc.)

Robert D Flach said...


Interesting situation.

I will be discussing my obligation if I discover an error or omission "after the fact" in Monday's post.

To be honest I am surprised that, as far as I can recall, this particular situation has never come up in my 38 tax seasons.

I do not discuss the specifics of one client with another, and, as the daughter is 22 and no longer a "minor" I do have an obligation to keep her confidence if she is a client.

The first thing I would do is to prepare the daughter's return properly and compare the federal and state tax savings she realizes from claiming herself and the education credit to the savings realized by the parents on the original return.

I often find that even if the parents could claim their student child as a dependent, because of the AGI threshold and phase-out the dependent will actually do better by claiming the education tax credit.

If I find that the daughter will actually save more in taxes by claiming herself and the education credit then the parents did it is easy. I just tell the parents that the family will pay less overall tax if they do not claim the daughter. There is no need to bring up the daughter's lies.

I find that a couple would much rather pay less overall to the government as long as the money stays in the family.

Otherwise I suppose what I must do is tell the parents that, based on the information received from the daughter, I have determined that they cannot claim her as a dependent. I would not go into details - other than maybe to say that her income is too high (which, in reaity, is true - since "full-time student" no longer applies). If they wanted more information they would have to get it from the daughter.

In either case I would prepare an amended return for the parents and a correct return for the daughter.

Of course the daughter could go to another tax preparer, tell them that her parents claim her as a dependent due to college (but not that she only went for 4 months), and have her return prepared as a dependent. But I could not prepare her return this way, as I have direct personal knowledge that she does not qualify as a dependent.

If the daughter works as a stripper, or more likely a "go-go dancer", my choice is to, again, simply tell the parents that the daughter's income is too high to be able to claim her as a dependent (if that were the case). I would not tell the parents of the nature of the income.

Now if the daughter was stupid enough to tell me that she was a dope dealer all bets are off. Because she is engaged in an obviously illegal profession I would certainly not prepare her return. I am not quite sure of my legal responsibility for confidentiality, as I am not a lawyer, but would certainly consider telling the parents, depending on my individual relationship with them.

What are your thoughts?


Anonymous said...

Anon replying here. I have actually faced quite a few situations similar to the Jones family over the years, which is why I felt the need to be anonymous.

Fortunately, in all situations I have encountered so far, I have always been able to convince the children that it was best to talk to their parents about the true facts of the situation, and for all three of them to return together to make sure that all facts relevant to the parents' eligibility to claim the child were on the table.

I have always been able to convince the parents and the child to file returns that were legally correct. If they don't want to be legal according to my interpretation of the facts when all cards are on the table, it's their prerogative to find another preparer. At least I've given them the facts. And all my taxpayers have chosen to amend returns according to my recommendations so they stay on the right side of the law.

But I've often wondered what I would do if the child didn't want to discuss the true facts of their situation with their parents.

And fortunately, I have never encountered a situation in which any taxpayer revealed illegal income of any sort. In such a case, I would advise the client as follows:

a)Illegal income is taxable income and must be declared.

b)In general, I rarely take clients whose income comes from a business outside my zone of expertise, because I would not be familiar with what is considered "ordinary and necessary" business expenses in that zone.

c)In some cases, I am willing to accept a new client whose business lies outside my zone of expertise, because I have the time and interest to research the nature of ordinary and necessary expenses for that business.

d)I do not have the time or interest to research those issues for his business, and he should find another preparer who does have the necessary expertise. Lawyers who specialize in defending drug offenders probably know someone who could do their taxes.

e)If I learned something from any client that suggested his behavior was a threat to the community's safety, I would feel obligated to notify the authorities.

Anonymous said...

Same anon again here.

The newly expanded kiddie tax raises some interesting issues, so let me give you another interesting scenario.

Mr. and Mrs. Smith are private people with a lot of income. They live very modestly and don't want their son Junior to know how much money they make. They are in the 35% tax bracket. They want their son to grow up self-sufficient, and they have always encouraged him to work part-time throughout high school and college, so Junior has worked at part-time jobs like lifeguarding and grocery-bagging for years.

You've prepared returns for parents and Junior for many years with no problems.

Junior is 22 and a full-time law student at the state university. Junior spent the summer before his first year of law school waiting tables in Atlantic City, where he was lucky enough to win $20,000 at the gambling tables in his spare time. He's proud to tell his parents he earned enough to pay more than 50% of his support for the year, so they don't claim him as their dependent.

You've already done the parents' returns before Junior comes in with his tax records. You crunch the numbers and realize that Junior's "earned income" is less than 50% of his support for the year, because the IRS doesn't consider the gambling winnings to be earned income (assuming he's not a pro gambler.)

This means that although Junior can still claim his own personal exemption, he is now subject to the expanded Kiddie Tax on his gambling income, which IRS rules consider "investment income" for the purposes of Form 8615.

Ouch! Because he's a full-time student under 24, he needs to file a return that includes Form 8615. This means he needs to report his parents' income on his tax return and pay taxes on his unearned income at their top tax rate of 35%, even though he's not their dependent.

But the parents don't want Junior to know their income. They don't even want you to tell Junior what tax bracket they're in. They're private and modest people who plan to leave the bulk of their estate to charity. They want their son to grow up self-sufficient.

What do you do now?

Robert D Flach said...

Anon –

I do not have the time, experience, or desire to get involved in family counseling during the tax season – or at any time of the year.

If a “child” is subject to the Kiddie Tax and must file a Form 8615 (i.e. parents cannot claim the child’s income on their own return) then information from the parents’ 1040 is required to be entered on the Form 8615. If I also prepared the parents return I have access to that information.

In such a case I am not divulging private information about one client to another client. I am not telling the child what tax bracket the parents are in and I am not “telling” the child the parents’ level of taxable income. I am properly completing the IRS form as per its instructions. If the child actually reads his/her tax return thoroughly he/she will obviously become aware of the parents’ level of income.

If, as in your example, the child is enrolled in a graduate degree I would expect that he is smart enough to have some idea as to his parents wealth just based solely on their standard of living – unless the parents truly live frugally and hoard every excess penny.

While your two “scenarios” have been interesting, it was not my intention in publishing this series to initiate a quiz on ethics issues. No more, please.


Anonymous said...

Sorry to be annoying.

It's certainly not the fault of the preparer, but as a parent who feels entitled to a measure of privacy, I'm troubled that the expanded kiddie tax now has the effect of revealing the parents' income to adult children in situations where the parents did absolutely nothing to transfer assets to the child's name.

This actually happened to me this year, though my child and I did not share the same tax pro and the income that triggered the kiddie tax in her case did not come from gambling income, but from another type of income considered "investment income" for purposes of the kiddie tax.

I'm not as obsessively private as some parents might be, so I agreed to provide the information my child's preparer needed for the 8615 on her tax return, but I must say that I found it intrusive. It wasn't her preparer's fault that she needed to ask me for that information.

I understand that in some cases, the preparer of a tax return for an adult child subject to kiddie tax would need access to her siblings' so-called investment income as well in order to prepare the 8615.

I understand that tax preparers are not family counselors, but the tax code sometimes puts them in the position where they need to advise their clients on how to get information from other family members. Given the troubled state of the American family these days, this can create a lot of difficulty in some circumstances.

Robert D Flach said...


Not annoying. You brought up interesting scenarios - just didn't want it to go on forever.

I admit I have been somewhat unneccessarily paranoid considering a personal attack by a fellow blogger.

It is true that the Tax Code can indeed put the tax preparer in the middle of unique family situations.

As for the current Kiddie Tax situation - when it was created it was limited to minor children, so there would be no potential for conflicts in needing parental and sibling information. When Congress extended it too far, as a typical over-reaction, the IRS kept the same format and did not consider the new possibilities for agita.

I trust you will remain a visitor and commentor.