Preparer Penalties

With the 2010 tax season so recently behind us, some taxpayers might be mindful of their risk should an IRS audit turn up an omission on their return; maybe an inadvertent understatement of income, or an expense claimed  that they know darned well they paid, but for which there just didn’t happen to be a receipt to prove it. If such seemingly innocent errors were to come to light, the IRS would not only make a demand for the taxes that were underpaid as a result, but penalties and interest as well.

But it is doubtful these same taxpayers give a thought to what would happen to their tax preparer in that case. So, for the record, let me take a moment to explain some of the risks I face when I sign my name to your tax return, if for no other reason than to give you an idea why I sometimes ask such probing questions about your finances.

As a basic rule, the IRS requires that all professional tax preparers exercise what is called “due diligence” in the completion of the tax return. In most instances this just means that I must show the same level of care and competence that other careful, competent professionals show. I don’t have to personally examine all your financial records, but I should at least remind you that you must be able to document any expenses you claim.

However, there are a few areas where due diligence actually requires me to either know certain facts, or make rather pointed inquiries to ascertain them. A good example is the Earned Income Credit. Due to a high level of fraud associated with this tax benefit, the IRS demands that I pose several quite specific questions to qualifying taxpayers. I must actually file a special tax form declaring that I have done so. Failure could result in financial penalties to me, not my clients, and a warning to clean up my act!

Even more serious are the penalties associated with willful or reckless misconduct, such as allowing a client to claim a deduction that I know for a fact he is not eligible for, or worse, helping him lie in order to feign eligibility. You might think I would never go to such an extent, and that you would never ask me to, but telling me that expenses of a certain kind were “about the same as last year” without providing more detail comes dangerously close.

Some tax preparers, of course, are not the least bit ashamed of committing fraud and literally guarantee a refund, regardless of whether their client’s financial condition warrants it. Others actively promote illegal tax shelters or frivolous tax positions (such as the oft-abused claim that there is no such thing as income tax under the Constitution, and therefore the IRS is illegal and taxpayers have no obligation to file a return*).

Since penalties for tax practitioners who fail to meet IRS standards range from $50 to thousands of dollars per return, plus jail time in case of fraud, a careless preparer could easily face financial ruin. Moreover, if the IRS believes that there is a clear pattern of such behavior, unintentionally or not, the Office of Professional Responsibility can even take away a preparer’s right to practice his profession.

That’s a penalty I am not willing to face. So please bear with me when we are working together if I appear to probe and pry into areas that you think are private. In all likelihood, I am simply trying to meet my IRS-mandated duty to exercise due diligence. As you can see, the penalties for filing a less than accurate return are not faced by you alone.

*For the record, it is true that the original Constitution, as drafted and signed by our founding fathers, did not contain a clause providing for the collection of an income tax. However, neither did it contain a clause granting a right to free speech. Both of those were subsequently added by amendment according to a strict process that was allowed for in the original Constitution. So the claim that an income tax is un-Constitutional is, at best, mistaken, but is so commonly claimed by schemers and conspiracy nuts that the courts have finally declared it abusive and won’t even grant a hearing to anyone who uses it as their basis for refusing to pay taxes. A great topic for another time!