What is the CPA’s Responsibly when Faced with Client Financial and Tax Fraud?

By David W. Klasing Esq. M.S.-Tax CPA

 

David W. Klasing Esq. CPA M.S.-Tax has earned dual California licenses that enable him to simultaneously practice as an Attorney and as a Certified Public Accountant in the practice areas of Taxation, Estate Planning and Business Law.  He provides businesses and individuals with comprehensive Tax Representation, Planning & Compliance Services and Criminal Tax Representation. He has more than 20 years of professional tax, accounting and business consulting experience, coupled with extensive knowledge about federal and state tax codes, regulations and case law.

As a former auditor, Mr. Klasing uses his past experience in public accounting to help his clients avoid tax problems before they develop where possible. As a Combo Attorney CPA he aggressively protects his clients’ interests during audits, criminal investigations or in Tax Litigation. Mr. Klasing has assisted thousands of businesses and individuals through the audit / litigation and appeal process, and Mr. Klasing has a proven and sustained record of achieving favorable results for the clients he serves.

Mr. Klasing is admitted to practice before all California State Courts, the United States District Court for the Central District of California and the United States Tax Court.

Mr. Klasing’s education includes a bachelor’s degree in business administration, with an emphasis in accounting, from California State University Los Angeles, a master’s degree in taxation from Golden Gate University and a Juris Doctor from Western State University College of Law.

Having earned a master’s degree in taxation with an emphasis in the gift and estate tax arena, along with having taken classes in Law School on Estate’s, Trusts and California Community Property, Mr. Klasing practices in the estate, trust and accounting areas.

Mr. Klasing’s professional involvement includes serving as the current Associate Secretary of the Executive Committee of the American Academy of Attorney Certified Public Accountants (AAA-CPA). He previously chaired the AAA-CPA Education Committee, was the (2012/2013) chair of the California State Bar Association, Tax Procedure and Litigation Committee, the 2013 chair of the Orange County Bar Association Taxation Section. He is also a member of the American Bar Association Tax Section; the Orange County Bar Association, Tax, Business and Corporate Law, Trust & Estate Sections, the California Society of Certified Public Accountants State Committee on Taxation. He is an “A+” rated current member of the Better Business Bureau.  He has a 10.0 AVVO rating (Superb)

Regulation of CPAs

CPAs are licensed and regulated by their state boards of accountancy. Additionally, all AICPA members are required to follow a rigorous Code of Professional Conduct which requires that they act with integrity, objectivity, due care, competence, fully disclose any conflicts of interest (and obtain client consent if a conflict exists), maintain client confidentiality, disclose to the client any commission or referral fees, and serve the public interest when providing financial services. The vast majority of state boards of accountancy have adopted the AICPA Code of Professional Conduct within their state accountancy laws or have created their own.

AICPA Code of Conduct 

AICPA members are bound by the AICPA Code of Professional Conduct. Rule 201 requires that members provide professional services with competency.

Excerpts from – AICPA Code of Professional Conduct

0.300.050 Objectivity and Independence

  • Objectivity and independence A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services.

 

  • Objectivity is a state of mind, a quality that lends value to a member’s It is a distinguishing feature of the profession. The principle of objectivity imposes the obligation to be impartial, intellectually honest, and free of conflicts of interest. Independence precludes relationships that may appear to impair a member’s objectivity in rendering attestation services.

 

  • Members often serve multiple interests in many different capacities and must demonstrate their objectivity in varying Members in public practice render attest, tax, and management advisory services. Other members prepare financial statements in the employment of others, perform internal auditing services, and serve in financial and management capacities in industry, education, and government. They also educate and train those who aspire to admission into the profession. Regardless of service or capacity, members should protect the integrity of their work, maintain objectivity, and avoid any subordination of their judgment.

 

  • For a member in public practice, the maintenance of objectivity and independence requires a continuing assessment of client relationships and public responsibility. Such a member who provides auditing and other attestation services should be independent in fact and appearance. In providing all other services, a member should maintain objectivity and avoid conflicts of

 

  • Although members not in public practice cannot maintain the appearance of independence, they nevertheless have the responsibility to maintain objectivity in rendering professional services. Members employed by others to prepare financial statements or to perform auditing, tax, or consulting services are charged with the same responsibility for objectivity as members in public practice and must be scrupulous in their application of generally accepted accounting principles and candid in all their dealings with members in public practice. [Prior reference: ET section 55]

1.000.010 Conceptual Framework for Members in Public Practice

 

  • Members may encounter various relationships or circumstances that create threats to the member’s compliance with the rules. The rules and interpretations seek to address many situations; however, they cannot address all relationships or circumstances that may arise. Thus, in the absence of an interpretation that addresses a particular relationship or circumstance, a member should evaluate whether that relationship or circumstance would lead a reasonable and informed third party who is aware of the relevant information to conclude that there is a threat to the member’s compliance with the rules that is not at an acceptable level. When making that evaluation, the member should apply the conceptual framework approach as outlined in this interpretation.

 

  • The code specifies that in some circumstances no safeguards can reduce a threat to an acceptable level. For example, the code specifies that a member may not subordinate the member’s professional judgment to others without violating the “Integrity and Objectivity Rule” [1.100.001]. A member may not use the conceptual framework to overcome this prohibition or any other prohibition or requirement in the code.

 

  • The “Conceptual Framework for Independence” interpretation [1.210.010] of  the  “Independence  Rule” [1.200.001] provides authoritative guidance that members should use when making decisions on independence matters that are not explicitly addressed by the “Independence Rule” and its interpretations.

 

Definitions Used in Applying the Conceptual Framework

 

  • Acceptable level. A level at which a reasonable and informed third party who is aware of the relevant information would be expected to conclude that a member’s compliance with the rules is not

 

  • Actions or other measures that may eliminate a threat or reduce a threat to an acceptable level.

 

  • Relationships or circumstances that could compromise a member’s compliance with the rules.

 

Conceptual Framework Approach

  • Under the conceptual framework approach, members should identify threats to compliance with the rules and evaluate the significance of those Members should evaluate identified threats both individually and in the aggregate because threats can have a cumulative effect on a member’s compliance with the rules. Members should perform three main steps in applying the conceptual framework approach:
    1. Identify threats. The relationships or circumstances that a member encounters in various engagements and work assignments will often create different threats to complying with the rules. When a member encounters a relationship or circumstance that is not specifically addressed by a rule or an interpretation, under this approach, the member should determine whether the relationship or circumstance creates one or more threats, such as those identified in paragraphs .10–.16 that The existence of a threat does not mean that the member is in violation of the rules; however, the member should evaluate the significance of the threat.
    2. Evaluate the significance of a threat. In evaluating the significance of an identified threat, the member should determine whether a threat is at an acceptable level. A threat is at an acceptable level when a reasonable and informed third party who is aware of the relevant information would be expected to conclude that the threat would not compromise the member’s compliance with the rules. Members should consider both qualitative and quantitative factors when evaluating the significance of a threat, including the extent to which existing safeguards already reduce the threat to an acceptable level. If the member evaluates the threat and concludes that a reasonable and informed third party who is aware of the relevant information would be expected to conclude that the threat does not compromise a member’s compliance with the rules, the threat is at an acceptable level, and the member is not required to evaluate the threat any further under this conceptual framework approach.
    3. Identify and apply safeguards. If, in evaluating the significance of an identified threat, the member concludes that the threat is not at an acceptable level, the member should apply safeguards to eliminate the threat or reduce it to an acceptable level. The member should apply judgment in determining the nature of the safeguards to be applied because the effectiveness of safeguards will vary, depending on the circumstances. When identifying appropriate safeguards to apply,   one safeguard may eliminate or reduce multiple threats. In some cases, the member should apply multiple safeguards to eliminate or reduce one threat to an acceptable level. In other cases, an identified threat may be so significant that no safeguards will eliminate the threat or reduce it      to an acceptable level, or the member will be unable to implement effective safeguards. Under such circumstances, providing the specific professional services would compromise the member’s compliance with the rules, and the member should determine whether to decline or discontinue the professional services or resign from the engagement.

 

Threats

 

  • Many threats fall into one or more of the following seven broad categories: adverse interest, advocacy, familiarity, management participation, self-interest, self-review, and undue influence.
  • Undue influence threat. The threat that a member will subordinate his or her judgment to an individual associated with a client or any relevant third party due to that individual’s reputation or expertise, aggressive or dominant personality, or attempts to coerce or exercise excessive influence over the member. Examples of undue influence threats include the following:
    1. The firm is threatened with dismissal from a client
    2. The client indicates that it will not award additional engagements to the firm if the firm continues to disagree with the client on an accounting or tax matter.

1.000.020 Ethical Conflicts

  • An ethical conflict arises when a member encounters one or both of the following:

 

  1. Obstacles to following an appropriate course of action due to internal or external pressures

 

  1. Conflicts in applying relevant professional standards or legal standards

 

For example, a member suspects a fraud may have occurred, but reporting the suspected fraud would violate the member’s responsibility to maintain client confidentiality.

 

  • Once an ethical conflict is encountered, a member may be required to take steps to best achieve compliance with the rules and In weighing alternative courses of action, the member should consider factors such as the following:

 

  1. Relevant facts and circumstances, including applicable rules, laws, or regulations

 

  1. Ethical issues involved

 

  1. Established internal procedures

 

  • The member should also be prepared to justify any departures that the member believes were appropriate in applying the relevant rules and law. If the member was unable to resolve the conflict in a way that permitted compliance with the applicable rules and law, the member may have to address the consequences of any violations.

 

  • Before pursuing a course of action, the member should consider consulting with appropriate persons within the firm or the organization that employs the member.

 

  • If a member decides not to consult with appropriate persons within the firm or the organization that employs the member and the conflict remains unresolved after pursuing the selected course of action, the member should consider either consulting with other individuals for help in reaching a resolution or obtaining advice from an appropriate professional body or legal The member also should consider documenting the substance of the issue, the parties with whom the issue was discussed, details of any discussions held, and any decisions made concerning the issue.

 

  • If the ethical conflict remains unresolved, the member will in all likelihood be in violation of one or more rules if he or she remains associated with the matter creating the Accordingly, the member should consider his or her continuing relationship with the engagement team, specific assignment, client, firm, or employer. [No prior reference: new content.]

1.100.001 Integrity and Objectivity Rule

.01           In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others. [Prior reference: paragraph .01 of ET section 102]

Interpretations Under the Integrity and Objectivity Rule

1.100.005 Application of the Conceptual Framework for Members in Public Practice and Ethical Conflicts

 

 

  • A member would be considered in violation of the “Integrity and Objectivity Rule” [100.001] if the member cannot demonstrate that safeguards were applied that eliminated or reduced significant threats to an acceptable level.

 

  • A member should consider the guidance in “Ethical Conflicts” [1.000.020] when addressing ethical conflicts that may arise when the member encounters obstacles to following an appropriate course of Such obstacles may be due to internal or external pressures or to conflicts in applying relevant professional or legal standards, or both. [No prior reference: new content]

1.110 Conflicts of Interest

1.110.010 Conflicts of Interest for Members in Public Practice

 

  • A member or his or her firm may be faced with a conflict of interest when performing a professional service. In determining whether a professional service, relationship or matter would result in a conflict of interest, a member should use professional judgment, taking into account whether a reasonable and informed third party who is aware of the relevant information would conclude that a conflict of interest exists.
    1. Providing tax or personal financial planning services for several members of a family whom the

member knows to have opposing interests

  1. Referring a personal financial planning or tax client to an insurance broker or other service provider, which refers clients to the member under an exclusive arrangement
  2. A client asks the member to provide tax or personal financial planning services to its executives, and the services could result in the member recommending to the executive’s actions that may be adverse to the company. [Prior reference: paragraphs .198–.199 of ET section 191]

1.130.020 Subordination of Judgment

  • The “Integrity and Objectivity Rule” [1.100.001] prohibits a member from knowingly misrepresenting facts or subordinating his or her judgment when performing professional services for a client, for an employer, or on a volunteer This interpretation addresses differences of opinion between a member and his or her supervisor or any other person within the member’s organization.
  • Self-interest, familiarity, and undue influence threats to the member’s compliance with the “Integrity and Objectivity Rule” [1.100.001] may exist when a member and his or her supervisor or any other person within the member’s organization have a difference of opinion relating to the application of accounting principles; auditing standards; or other relevant professional standards, including standards applicable to tax and consulting services or applicable laws or regulations.

1.140 Client Advocacy

1.140.010 Client Advocacy

 

  • An advocacy threat to compliance with the “Integrity and Objectivity Rule” [1.100.001] may exist when a member or the member’s firm is engaged to perform nonattest services, such as tax and consulting services, that involve acting as an advocate for the client or to support a client’s position on accounting or financial reporting issues either within the firm or outside the firm with standard setters, regulators, or others.
  • Advocacy The threat that a member will promote an attest client’s interests or position to the point that his or her independence is compromised. Examples of advocacy threats include the following:
    • A member promotes the attest client’s securities as part of an initial public offering. [295.130]

 

  • A member provides expert witness services to an attest client. [295.140]

 

  • A member represents an attest client in U.S. tax court or other public forum. [295.160]

 

Litigation Between the Attest Client and Member

 

  • When an attest client’s present management commences, or expresses an intention to commence, legal action against a covered member, the covered member and the attest client’s management may be placed in adversarial positions in which self-interest may affect the covered member’s objectivity and management’s willingness to make complete disclosures.
  • Accordingly, independence may be impaired whenever the covered member and the covered member’s attest client or its management are in threatened or actual positions of material adverse interests due to threatened or actual litigation.
  • Situations involving threatened or actual litigation are complex and diverse, making it difficult to identify precise points at which threats to the covered member’s compliance with the “Independence Rule” [1.200.001] would be at an acceptable level. There are situations regarding litigation between covered members and attest clients in which threats to the covered member’s compliance with the “Independence Rule” would not be at an acceptable level and could not be reduced to an acceptable level by safeguards and independence would be impaired. Examples of these situations are:
    1. An attest client’s present management commences litigation alleging deficiencies in audit work performed for the attest client or expresses its intention to commence such litigation, and the covered member concludes that it is probable that such a claim will be
    2. A covered member commences litigation against an attest client’s present management alleging management fraud or deceit.
  • If threatened or actual litigation is unrelated to the performance of a client’s attest engagement and is for an amount that is not material to the covered member’s firm or the attest client, threats to the covered member’s compliance with the “Independence Rule” [1.200.001] would be at an acceptable level, and independence would not be impaired. Such claims may arise, for example, out of immaterial disputes regarding billings for services, results of tax or management services advice, or similar matters.

 

 

Litigation by Security Holders

 

  • A covered member may also become involved in litigation (primary litigation) in which the covered member and the attest client or its management are For example, one or more stockholders may bring a stockholders’ derivative action or class-action lawsuit against the attest client or its management, the attest client’s officers, directors, or underwriters, and covered members.
  • Such primary litigation by itself would not threaten the covered member’s compliance with the “Independence Rule” [1.200.001]. However, if other circumstances exist that may create threats, the covered member should apply the “Conceptual Framework for Independence” interpretation [1.210.010] to evaluate whether the threats are at an acceptable level. For example, threats will exist if cross-claims are filed against the covered member alleging that the covered member is responsible for any deficiencies in work performed for the attest client or if the covered member, as a defense, alleges that the attest client’s management engaged in fraud or deceit.

Other Third-Party Litigation

 

  • A lending institution or other creditor, security holder, or insurance company that alleges reliance on the attest client’s financial statements as a basis for having extended credit or insurance coverage to an attest client may commence third-party litigation against the covered member to recover their loss. An example is an insurance company commencing litigation either as a result of receiving an assignment of a claim or under subrogation rights against the covered member in the attest client’s name to recover losses that the insurer reimbursed to the attest client. If the attest client is only the nominal plaintiff, threats to the covered member’s compliance with the “Independence Rule” [1.200.001] would be at an acceptable level unless other circumstances exist, such as when the covered member alleges, as a defense, that present management engaged in fraud or deceit. The attest client is a nominal plaintiff when the insurance company or lender sues in the name of the attest client as a result of obtaining subrogation rights or an assignment from the attest client and the attest client does not have a beneficial interest in the claim.

1.295.040 General Requirements for Performing Nonattest Services

  • When a member performs a nonattest service for an attest client, threats to the member’s compliance with the “Independence Rule” [1.200.001] may exist. Unless an interpretation of the “Nonattest Services” subtopic [1.295] under the “Independence Rule” states otherwise, threats would be at an acceptable level, and independence would not be impaired, when all the following safeguards are met:
    1. The member determines that the attest client and its management agree to

 

  1. assume all management responsibilities as described in the “Management Responsibilities” interpretation [1.295.030].
  2. oversee the service, by designating an individual, preferably within senior management, who possesses suitable skill, knowledge, and/or The member should assess and be satisfied that such individual understands the services to be performed sufficiently to oversee them. However, the individual is not required to possess the expertise to perform or re-perform the services.
  • evaluate the adequacy and results of the services performed.

 

  1. accept responsibility for the results of the services.

 

  1. The member does not assume management responsibilities (See the “Management Responsibilities” interpretation [1.295.030] of the “Independence Rule”) when providing nonattest services and the member is satisfied that the attest client and its management will
    1. be able to meet all of the criteria delineated in item a;

 

  1. make an informed judgment on the results of the member’s nonattest services; and

 

  • accept responsibility for making the significant judgments and decisions that are the proper responsibility of management.

If the attest client is unable or unwilling to assume these responsibilities (for example, the attest client cannot oversee the nonattest services provided or is unwilling to carry out such responsibilities due to lack of time or desire), the member’s performance of nonattest services would impair independence.

  1. Before performing nonattest services the member establishes and documents in writing his or her understanding with the attest client (board of directors, audit committee, or management, as appropriate in the circumstances) regarding
    1. objectives of the engagement,

 

  1. services to be performed,

 

  • attest client’s acceptance of its responsibilities,

 

  1. member’s responsibilities, and

 

  1. any limitations of the engagement.

1.295.155 Investment Advisory or Management

  • When a member provides investment advisory or management services to an attest client, self-review and management participation threats to the covered member’s compliance with the “Independence Rule” [1.200.001] may exist.

 

If the member applies the “General Requirements for Performing Nonattest Services” interpretation [1.295.040] of the “Independence Rule” [1.200.001], threats would be at an acceptable level and independence would not be impaired.

1.295.160 Tax Services

 

  • For purposes of this interpretation, tax services include preparation of a tax return, transmittal of a tax return, and transmittal of any related tax payment to the taxing authority, signing and filing a tax return, having a power of attorney limited strictly to tax matters; and authorized representation of attest clients in administrative proceedings before a taxing authority.

 

  • For purposes of this interpretation, a tax return includes all tax filings, including informational tax forms (such as estimated tax vouchers), extension forms, and Forms 990, 5500, 1099, and W-2, filed with a taxing authority or other regulatory agency.

 

  • Preparation and When a member prepares a tax return and transmits the tax return and related tax payment to a taxing authority in paper or electronic form, self-review and management participation threats to the member’s compliance with the “Independence Rule” [1.200.001] may exist. If the member applies the “General Requirements for Performing Nonattest Services” interpretation [1.295.040] of the “Independence Rule,” threats would be at an acceptable level and independence would not be impaired, provided that the member does not have custody or control over the attest client’s funds or assets and the individual designated by the attest client to oversee the tax services

 

  1. reviews and approves the tax return and related tax payment.

 

  1. if required for filing, signs the tax return prior to the member transmitting the return to the taxing authority.

 

The following are not considered having custody or control over an attest client’s funds: making electronic tax payments authorized by an attest client pursuant to a taxing authority’s prescribed criteria (as discussed in paragraph .04), affixing the attest client’s depository account information on a tax return, or remitting an attest client’s check made payable to the taxing authority.

 

  • If the member applies the “General Requirements for Performing Nonattest Services” interpretation [1.295.040] of the “Independence Rule” [1.200.001], threats would be at an acceptable level and independence would not be impaired when a member signs and files a tax return on behalf of management, provided that the member has the legal authority to do so and

 

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

 

  1. an individual in management who is authorized to sign and file the attest client’s tax return provides the member with a signed statement that clearly identifies the return being filed and represents that such individual

 

  1. is authorized to sign and file the tax return.
  2. has reviewed the tax return, including accompanying schedules and statements, and it is true, correct, and complete to the best of the individual’s knowledge and belief.

 

  • authorizes the member or another named individual in the member’s firm to sign and file the tax return on the attest client

1.400.030 Failure to File a Tax Return or Pay a Tax Liability

.01           A member who fails to comply with applicable federal, state, or local laws or regulations regarding (a) the timely filing of the member’s personal tax returns or tax returns of the member’s firm that the member has the authority to timely file or (b) the timely remittance of all payroll and other taxes collected on behalf of others may be considered to have committed an act discreditable to the profession, in violation of the “Acts Discreditable Rule” [1.400.001]. [Prior reference: paragraph .08 of ET section 501]

Disclosing Information From Previous Engagements

  • When a member evaluates whether to accept a new client engagement, the member should consider whether knowledge and experience that the member or member’s firm will share while providing the professional services to the prospective client would be confidential client information. If such information would be confidential client information, and the circumstances are such that the prospective client would be able to identify the client or clients that are the source of the information, the engagement should not be accepted unless the member obtains the original client’s specific consent to disclose the [Prior reference: paragraphs .029–.030 of ET section 391]

1.700.030 Disclosing Information to Persons or Entities Associated With Clients

  • When a member is engaged to prepare a married couple’s joint tax return, both spouses are considered to be the member’s client, even if the member was engaged by one spouse and deals exclusively with that

 

  • Accordingly, if the married couple is undergoing a divorce and one spouse directs the member to withhold joint tax information from the other spouse, the member may provide the information to both spouses, in compliance with the “Confidential Client Information Rule” [1.700.001], because both are the member’s client. The member should consider reviewing

 

  1. the legal implications of such disclosure with an attorney and

 

  1. responsibilities under any tax performance standards, such as Section 10.29 of IRS Circular 230. [Prior reference: paragraphs .031–.032 of ET section 391]

 

  • If a member provides professional services to a company’s executives at the request of the company, the member’s disclosure of confidential client information to the company without the consent of the applicable executives would be a violation of the “Confidential Client Information Rule” [1.001], even if the company is not otherwise a client. [Prior reference: paragraphs .041–.042 of ET section 391]

Members in Business

2.000 Introduction

 

  • Part 2 of the Code of Professional Conduct (the code) applies to members in business. Accordingly, when the term member is used in part 2 of the code, the requirements apply only to members in business. When a member in business is also a member in public practice (for example, a member has a part-time tax practice), the member should also consult part 1 of the code, which applies to members in public practice. [No prior reference: new content]
  • Undue influence threat. The threat that a member will subordinate his or her judgment to that of an individual associated with the employing organization or any relevant third party due to that individual’s position, reputation or expertise, aggressive or dominant personality, or attempts to coerce or exercise excessive influence over the member. Examples of undue influence threats include the following:
    1. A member is pressured to become associated with misleading
    2. A member is pressured to deviate from a company
    3. A member is pressured to change a conclusion regarding an accounting or a tax
    4. A member is pressured to hire an unqualified

 

2.000.020 Ethical Conflicts

 

  • An ethical conflict arises when a member encounters one or both of the following:

 

  1. Obstacles to following an appropriate course of action due to internal or external pressures

 

  1. Conflicts in applying relevant professional and legal standards.

 

For example, a member suspects a fraud may have occurred, but reporting the suspected fraud would violate the member’s responsibility to maintain the confidentiality of his or her employer’s confidential information.

2.400.030 Failure to File a Tax Return or Pay a Tax Liability

 

.01           A member who fails to comply with applicable federal, state, or local laws or regulations regarding (a) the timely filing of the member’s personal tax returns or tax returns for the member’s employer that the member has the authority to timely file or (b) the timely remittance of all payroll and other taxes collected on behalf of others may be considered to have committed an act discreditable to the profession, in violation of the “Acts Discreditable Rule” [2.400.001]. [Prior reference: paragraph .08 of ET section 501]

 

Excerpts from – AICPA’s Statements on Standards for Tax Services

Preface

  1. Standards are the foundation of a profession. The AICPA aids its members in fulfilling their ethical responsibilities by instituting and maintaining standards against which their professional performance can be measured. Compliance with professional standards of tax practice also reaffirms the public’s awareness of the professionalism that is associated with CPAs as well as the AICPA .

 

Statement on Standards for Tax Services No. 1, Tax Return Positions

  1. If the applicable taxing authority has no written standards with respect to recommending a tax return position or preparing or signing a tax return, or if its standards are lower than the standards set forth in this paragraph, the following standards will apply:
    1. A member should not recommend a tax return position or prepare or sign a tax return taking a position unless the mem- ber has a good-faith belief that the position has at least a re- alistic possibility of being sustained administratively or judi- cially on its merits if challenged .
    2. Notwithstanding paragraph 5(a), a member may recommend a tax return position if the member (i) concludes that there is a reasonable basis for the position and (ii) advises the tax- payer to appropriately disclose that position. Notwithstanding paragraph 5(a), a member may prepare or sign a tax return that reflects a position if (i) the member concludes there is a reasonable basis for the position and (ii) the position is appropriately disclosed .
  2. When recommending a tax return position or when preparing or signing a tax return on which a position is taken, a member should, when relevant, advise the taxpayer regarding potential penalty con- sequences of such tax return position and the opportunity, if any, to avoid such penalties through disclosure.
  3. A member should not recommend a tax return position or pre- pare or sign a tax return reflecting a position that the member knows
    1. exploits the audit selection process of a taxing authority, or
    2. serves as a mere arguing position advanced solely to obtain leverage in a negotiation with a taxing authority.

Explanation

  1. In addition to a duty to the taxpayer, a member has a duty to the tax system. However, it is well established that the taxpayer has no obligation to pay more taxes than are legally owed, and a member has a duty to the taxpayer to assist in achieving that result. The standards contained in paragraphs 4–8 recognize a member’s responsibilities to both the taxpayer and the tax system.

 

Statement on Standards for Tax Services No. 2, Answers to Questions on Returns

  1. A member should make a reasonable effort to obtain from the taxpayer the information necessary to provide appropriate answers to all questions on a tax return before signing as

Statement on Standards for Tax Services No. 3, Certain Procedural Aspects of Preparing Returns

  1. In preparing or signing a return, a member may in good faith rely, without verification, on information furnished by the taxpayer or by third parties. However, a member should not ignore the implications of information furnished and should make reasonable inquiries if the information furnished appears to be incorrect, incomplete, or inconsistent either on its face or on the basis of other facts known to the Further, a member should refer to the taxpayer’s returns for one or more prior years whenever feasible.
  2. If the tax law or regulations impose a condition with respect to deductibility or other tax treatment of an item, such as taxpayer maintenance of books and records or substantiating documentation to support the reported deduction or tax treatment, a member should make appropriate inquiries to determine to the member’s satisfaction whether such condition has been met.

Statement on Standards for Tax Services No. 4, Use of Estimates

Introduction

 

  1. This statement sets forth the applicable standards for members when using the taxpayer’s estimates in the preparation of a tax return. A member may advise on estimates used in the preparation    of a tax return, but the taxpayer has the responsibility to provide the estimated data. Appraisals or valuations are not considered estimates for purposes of this statement.

Statement

  1. Unless prohibited by statute or by rule, a member may use the taxpayer’s estimates in the preparation of a tax return if it is not practical to obtain exact data and if the member determines that the estimates are reasonable based on the facts and circumstances known to the member. The taxpayer’s estimates should be presented in a manner that does not imply greater accuracy than exists.

Statement on Standards for Tax Services No. 5, Departure From a Position Previously Concluded in an Administrative Proceeding or Court Decision

Introduction

  1. This statement sets forth the applicable standards for members in recommending a tax return position that departs from the position determined in an administrative proceeding or in a court decision with respect to the taxpayer’s prior return.

Statement on Standards for Tax Services No. 6, Knowledge of Error: Return Preparation and Administrative Proceedings

Statement

  1. A member should inform the taxpayer promptly upon becoming aware of an error in a previously filed return, an error in a return that is the subject of an administrative proceeding, or a taxpayer’s failure to file a required return. A member also should advise the taxpayer of the potential consequences of the error and recommend the corrective measures to be taken. Such advice and recommendation may be given The member is not allowed to inform the taxing authority without the taxpayer’s permission, except when required by law.
  2. If a member is requested to prepare the current year’s return and the taxpayer has not taken appropriate action to correct an error in a prior year’s return, the member should consider whether to with- draw from preparing the return and whether to continue a professional or employment relationship with the If the member does prepare such current year’s return, the member should take reasonable steps to ensure that the error is not repeated.
  3. If a member is representing a taxpayer in an administrative proceeding with respect to a return that contains an error of which the member is aware, the member should request the taxpayer’s agreement to disclose the error to the taxing Lacking such agreement, the member should consider whether to withdraw from representing the taxpayer in the administrative proceeding and whether to continue a professional or employment relationship with the taxpayer.

Statement on Standards for Tax Services No. 7, Form and Content of Advice to Taxpayers

Statement

  1. A member should use professional judgment to ensure that tax advice provided to a taxpayer reflects competence and appropriately serves the taxpayer’s When communicating tax advice to a taxpayer in writing, a member should comply with relevant taxing authorities’ standards, if any, applicable to written tax advice. A member should use professional judgment about any need to document oral advice. A member is not required to follow a standard format when communicating or documenting oral advice.
  2. A member should assume that tax advice provided to a tax- payer will affect the manner in which the matters or transactions considered would be reported or disclosed on the taxpayer’s tax returns. Therefore, for tax advice given to a taxpayer, a member should consider, when relevant (a) return reporting and disclosure standards applicable to the related tax return position and (b) the potential penalty consequences of the return position. In ascertaining applicable return reporting and disclosure standards, a member should follow the standards in Statement on Standards for Tax Services No. 1, Tax Return Positions.
  3. A member has no obligation to communicate with a taxpayer when subsequent developments affect advice previously provided with respect to significant matters, except while assisting a taxpayer in implementing procedures or plans associated with the advice provided or when a member undertakes this obligation by specific agreement.

CALIFORNIA BOARD OF ACCOUNTANCY REGULATIONS (Excerpts)

Article 13- Denial, Suspension, and Revocation of Certificates, Permits, or Licenses

  • 98. Disciplinary Guidelines.

In reaching a decision on a disciplinary action under the Administrative Procedure Act (Government Code Section 11400 et seq.), the Board shall consider the disciplinary guidelines entitled “Disciplinary Guidelines and Model Orders” (9th edition, 2013), which are hereby incorporated by reference. Deviation from these guidelines and orders, including the standard terms of probation, is appropriate where the Board in its sole discretion determines that the facts of the particular case warrant such a deviation, for example: the presence of mitigating factors; the age of the case; evidentiary problems.

 

Note: Authority cited: Sections 5010, 5018 and 5116, Business and Professions Code; and Section 11400.20, Government Code. Reference: Sections 5018, 5096, 5096.5, 5096.12, 5100 and 5116-5116.6, Business and Professions Code; and Section 11425.50(e), Government Code.

  • 99. Substantial Relationship Criteria.

For the purposes of denial, suspension, or revocation of a certificate or permit pursuant to Division 1.5 (commencing with Section 475) of the Business and Professions Code, a crime or act shall be considered to be substantially related to the qualifications, functions or duties of a certified public accountant or public accountant if to a substantial degree it evidences present or potential unfitness of a certified public accountant or public accountant to perform the functions authorized by his or her certificate or permit in a manner consistent with the public health, safety, or welfare. Such crimes or acts shall include but not be limited to those involving the following:

 

  • Dishonesty, fraud, or breach of fiduciary responsibility of any kind;
  • Fraud or deceit in obtaining a certified public accountant’s certificate or a public accountant’s permit under Chapter 1, Division III of the Business and Professions Code;
  • Gross negligence in the practice of public accountancy or in the performance of the bookkeeping operations described in Section 5052 of the code;
  • Violation of any of the provisions of Chapter 1, Division III of the Business and Professions Code or willful violation of any rule or regulation of the

 

Note: Authority cited: Sections 5010 and 5018, Business and Professions Code. Reference: Sections 481 and 5100, Business and Professions Code.

California Code, Business and Professions Code – BPC § 5018

 

The board may by regulation, prescribe, amend, or repeal rules of professional conduct appropriate to the establishment and maintenance of a high standard of integrity and dignity in the profession.

 

Every licensee of the California Board of Accountancy in this state shall be governed and controlled by the rules and standards adopted by the board.

California Code, Business and Professions Code – BPC § 48

Each board under the provisions of this code shall develop criteria to aid it, when considering the denial, suspension or revocation of a license, to determine whether a crime or act is substantially related to the qualifications, functions, or duties of the business or profession it regulates.

California Code, Business and Professions Code – BPC § 5100

After notice and hearing the board may revoke, suspend, or refuse to renew any permit or certificate granted under Article 4 (commencing with Section 5070) and Article 5 (commencing with Section 5080), or may censure the holder of that permit or certificate for unprofessional conduct that includes, but is not limited to, one or any combination of the following causes:

 

(a) Conviction of any crime substantially related to the qualifications, functions and duties of a certified public accountant or a public accountant.

(c) Dishonesty, fraud, gross negligence, or repeated negligent acts committed in the same or different engagements, for the same or different clients, or any combination of engagements or clients, each resulting in a violation of applicable professional standards that indicate a lack of competency in the practice of public accountancy or in the performance of the bookkeeping operations described in Section 5052.

(h) Suspension or revocation of the right to practice before any governmental body or agency.

(i) Fiscal dishonesty or breach of fiduciary responsibility of any kind.

(j) Knowing preparation, publication, or dissemination of false, fraudulent, or materially misleading financial statements, reports, or information.

(k) Embezzlement, theft, misappropriation of funds or property, or obtaining money, property, or other valuable consideration by fraudulent means or false pretenses.

(l) The imposition of any discipline, penalty, or sanction on a registered public accounting firm or any associated person of such firm, or both, or on any other holder of a permit, certificate, license, or other authority to practice in this state, by the Public Company Accounting Oversight Board or the United States Securities and Exchange Commission, or their designees under the Sarbanes-Oxley Act of 2002 or other federal legislation.

 

(m) Unlawfully engaging in the practice of public accountancy in another state.

  • 62. Contingent Fees.
  • A licensee shall not:
    • Perform for a contingent fee any professional services for, or receive such a fee from, a client for whom the licensee or the licensee’s firm performs:
      • an audit or review of a financial statement; or
      • a compilation of a financial statement when the licensee expects or reasonably should expect that a third party will use the financial statement and the licensee’s compilation report does not disclose a lack of independence; or
      • an examination of prospective financial information; or
      • any other attest engagement when the licensee expects or reasonably should expect that a third party will use the related attestation report; or
      • any other services requiring
    • Prepare an original tax return for a contingent fee for any
    • Prepare an amended tax return, claim for tax refund, or perform other similar tax services for a contingent fee for any
    • Perform an engagement as a testifying expert for a contingent

The prohibition in (a)(1) above applies during the period in which the licensee or the licensee’s firm is engaged to perform any of the services listed under (a)(1) above and the period covered by any historical financial statements involved in any such listed services.

  • Except as stated in the next paragraph, a contingent fee is a fee established for the performance of any service pursuant to an arrangement in which no fee will be charged unless a specific finding or result is attained, or in which the amount of the fee is otherwise dependent upon the finding or result of such

Solely for purposes of this section, fees are not regarded as being contingent if fixed by courts or governmental entities acting in a judicial or regulatory capacity, or in tax matters if determined based upon the results of judicial proceedings or the findings of governmental agencies in a judicial or regulatory capacity or there is a reasonable expectation of substantive review by a taxing authority.

 

Note: Authority cited: Sections 5010 and 5018, Business and Professions Code. Reference: Sections 5018, Business and Professions Code.

  • 68.1. Working Papers Defined; Retention.
  • Working papers are the licensee’s records of the procedures applied, the tests performed, the information obtained and the pertinent conclusions reached in an audit, review, compilation, tax, special report or other engagement. They include, but are not limited to, audit of other programs, analyses, memoranda, letters of confirmation and representations, abstracts of company documents and schedules or commentaries prepared or obtained by the licensee. The form of working papers may be handwriting, typewriting, printing, photocopying, photographing, computer, data, or any other letters, words, pictures, sounds, or symbols or combinations thereof.
  • Licensees shall adopt reasonable procedures for the safe custody of working papers and shall retain working papers for a period sufficient to meet the needs of the licensee’s practice and to satisfy applicable professional standards and pertinent legal requirements for record

 

  • Licensees shall retain working papers during the pendency of any Board investigation, disciplinary action, or other legal action involving the licensee. Licensees shall not dispose of such working papers until notified in writing by the Board of the closure of the investigation or until final disposition of the legal action or proceeding if no Board investigation is

 

Note: Authority: Sections 5010 and 5018, Business and Professions Code. Reference: Sections 5018 and 5037, Business and Professions Code.

BEFORE THE

CALIFORNIA BOARD OF ACCOUNTANCY DEPARTMENT OF CONSUMER AFFAIRS

STATE OF  CALIFORNIA

. In the Matter of the Accusation Against:

 

STEVEN MARK PYBRUM

 

Certified Public Accountant Certificate No. 31088,

 

PYBRUM & COMPANY, LLP

 

Certified Public Accountant Partnership Certificate No. 7514,

 

Respondents.

Case No. AC-2013-36 OAH No. 2015060269

FACTUAL FINDINGS (Excerpts)

On October 25, 2012, in the United States District Court, Central District of California, respondent was convicted by ·a jury of four felony counts charging violations of 26 United States Code Section 7206(1), willfully subscribing false federal income tax returns. On March 4, 2013, the court sentenced respondent to 36 months in prison. After completing his prison term, respondent was placed on and is currently serving his term of supervised release.

The facts and circumstances underlying the conviction were that respondent filed false individual income tax returns from 1999 through 2002. Respondent underreported individual income during these four years as part of a sophisticated scheme to avoid paying taxes on money he earned from accounting services. In 1998, respondent incorporated the “Foundation for Harmony and Happiness” (Foundation) as a 501(c)(3) charitable organization with the stated purpose of helping married couples with financial problems. During the four-year period noted above, respondent reported nearly all of the income he earned as a CPA for services he performed for accounting clients in the Foundation’s tax returns. He falsely characterized almost all of his income during this period as money the Foundation received through lawful charitable activities, when in fact this was income earned for the accounting services he provided for private accounting clients.

The facts and circumstances underlying the conviction were that respondent filed false individual income tax returns from 1999 through 2002. Respondent underreported individual income during these four years as part of a sophisticated scheme to avoid paying taxes on money he earned from accounting services. In 1998, respondent incorporated the “Foundation for Harmony  and Happiness” (Foundation) as a 501(c)(3) charitable organization with the stated purpose of helping married couples with financial problems. During the four-year period noted above, respondent reported nearly all of the income he earned as a CPA for services he performed for accounting clients in the Foundation’s tax returns. He falsely characterized almost all of his income during this period as money the Foundation received through lawful charitable activities, when in fact this was income earned for the accounting services he provided for private accounting clients.

In 1998, respondent declared an individual gross income in the amount of $214,591. During the four subsequent yearn, which form bases of his fom-count conviction, respondent: reported business gross income from his CPA practice in the following amounts: $5,782 in 1999; zero in 2000; $4,956 in 2001; and $2,705 in 2002.

Most of the income that respondent earned during the above-referenced years, for performing work requiring a CPA certificate, was reported in the Foundation’s tax returns as charitable gifts, grants or contributions.

Respondent testified that the IRS was well aware that the Foundation would perform tax related services, including preparation of tax returns for individuals and corporations. Respondent’s testimony is not credible.  In respondent’s application for exempt status under IRS Code section 501(c)(3) (application), he stated that the purpose of the Foundation was to “conduct basic social research in the emotional and psychological differences between men and women, to increase public awareness about the importance of achieving and maintaining effective communication skills between married couples and adults generally, and to instruct married couples about the multiple methods and techniques for wealth accumulation which may lead to a more stable and enduring marriage or relationship.”

Respondent testified that he did not know that he was engaging in illegal or prohibited conduct. Respondent’s testimony is not persuasive, He had almost 20 years’ experience wording as a CPA when he engaged in this fraudulent conduct.

LEGAL CONCLUSIONS (Excerpts)

 

Cause exists to suspend or revoke the respondent’s CPA certificate pursuant to Business and Professions Code sections 490 and 5100, subdivision (a), and 5106, based on respondent’s four-count felony conviction set forth in Factual Finding 4.

Cause exists to suspend or revoke the respondent’s CPA certificate pursuant to Business and Professions Code section 5100, subdivision (c), based on respondent’s dishonest conduct underlying his conviction, as set forth in Factual Findings 5 and 6.

Cause exists to suspend or revoke the respondent’s CPA certificate pursuant to Business and Professions Code section 5100, subdivision (i), based on respondent’s conduct evidencing fiscal dishonesty by willfully preparing and subscribing four false federal individual income tax returns, as set forth in Factual Findings 4, 5 and 6.

Cause exists to suspend or revoke the respondent’s CPA certificate pursuant to Business and Professions Code section 5100, subdivision G), based on respondent’s conduct of knowingly preparing false, fraudulent and materially misleading financial statement, as set forth in Factual Findings 5 and 6.

Cause exists to suspend or revoke the respondent’s CPA certificate pursuant to Business and Professions Code section 5100, subdivision (g), in that respondent willfully violated the Accountancy Act, and the rules and regulations promulgated by the Board pursuant to the Act.

In this case, respondent committed felony offenses that are directly related to the duties, functions and qualifications of a CPA. Although respondent was convicted of the offenses in 2012, respondent’s misconduct of filing false tax returns occurred in 2004 (12 years ago). When respondent became aware that he was under investigation by the IRS and federal authorities, he stopped his four-year practice of intermingling and  applying  his income  from  his  CPA practice  to the Foundation.  Since his conviction, respondent has been in compliance with the terms of his probation and supervised release.   However, respondent has not accepted responsibility for his criminal conduct.

ORDER (Excerpts)

 

 

Certified Public Accountant No. 31088, previously issued to respondent Steven Mark Pybrum, is revoked.

Government Regulation of Tax Advisors:

The Treasury Department dictates rules governing practice before the IRS under Circular 230. These rules were substantially strengthened and modified after the IRS identified and attacked several high-profile individual and corporate tax shelters in recent decades. These rules address standards by which tax advisors must conduct their practice and dictate the competence level required of tax advisors that render tax opinions. Under Circular 230 a practitioner rendering a covered opinion must use reasonable efforts to identify and ascertain the pertinent facts and must not base their opinion on unreasonable factual assumptions and must relate the correct applicable tax law to the correct relevant facts. Additionally, the opinion must not unreasonably assume a favorable resolution of any significant relevant tax issues addressed and must consider all significant tax issues in reaching the practitioner’s conclusion as to the likelihood that the taxpayer will prevail on the merits with respect to each significant federal tax issue considered in the opinion.  The opinion is prohibited from taking into account the possibility that a tax position will not be audited or that an issue will not be raised in any subsequent audit, or that an issue raised at audit will be favorably resolved through settlement.

The Internal Revenue Service has the power to censure, discipline, fine or remove the right to practice on any practitioner that is proves to be incompetent, disreputable or simply fails to comply with the prohibited conduct standards.  It can do the same where it proves a practitioner willfully and knowingly defrauded, mislead or threatened a client or prospective client.

Potential Tax Practitioner Criminal Liability:

It is important to emphasize the obvious, that tax evasion is a very different concept than tax avoidance is. Tax avoidance involves the careful, legal structuring of one’s affairs so his or her tax liability is legally reduced or minimized. Tax avoidance is legal. As one famous judge put it, “one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.” Helvering v. Gregory, 69 F.2d 809, 810-11 (2d Cir. 1934). Tax evasion, by contrast, is not legal and it involves the willful attempt to avoid paying one’s tax liability after it has been incurred.

A tax practitioner can be found guilty to the same extent as the taxpayer who actually owes the taxes. This is because the scope of tax evasion is defined broadly in Section 7201. Specifically, Section 7201 provides that tax evasion includes a person’s attempt “in any manner”—including helping another—“to evade or defeat any tax” or its payment (emphasis added). Thus, the statute allows the IRS to prosecute any person for the evasion of another’s tax liability. The defendant need not be the taxpayer in question.

To successfully prosecute a violation of the aiding or assisting provisions for aiding or assisting another to file a false form, the government must prove beyond a reasonable doubt that:

  1. The defendant aided, assisted, procured, counseled, or advised the
    preparation or presentation of a document;
  2. The document was false as to a material matter; and
  3. The defendant acted willfully.

Charges under this provision are most often brought against, accountants, bookkeepers and others (including an entity’s employees) who prepare or assist in the preparation of tax returns. However, the statute is not limited solely to the direct preparation of a return, but is actually much broader in that the statute reaches any intentional conduct that contributes to the presentation of a false document to the IRS.

To be charged under these provisions, one need only assist in the preparation of, and need not sign or file, the actual false document. The statute has thus been applied to individuals who communicate false information to their return preparers, thereby causing the tax preparer to file a false return. On the other hand, the statute specifically provides that the taxpayer who signs and files the return or document need not know of, or consent to, the false statement for the aiding and abetting statue to be brought against the preparer. For example, a tax preparer who inflates deductions understates income, or claims false credits on a client’s return may be charged with aiding and abetting even if the taxpayer for whom the return is prepared is unaware of the falsity of the return he signed and filed. Moreover, a tax preparer who utilizes information provided by a client that the preparer knows to be false, in the preparation of a return can be criminally charged with assisting in the preparation of a false return.

The courts that have ruled on what constitutes a material matter have held materiality to be a matter of law to be decided by the court and not a factual issue to be decided by the jury.

To establish willfulness in the delivery or disclosure of a false document, the government need only show that the accused knew that the law required a truthful document to be submitted and that he or she intentionally violated the duty to be truthful. The crime of aiding or assisting in the preparation or presentation of a false return or document requires that the defendant’s actions be willful in that the defendant knew or believed that his or her actions were likely to lead to the filing of a false return. The Ninth Circuit has held that the government must prove not only that the accused knew that the conduct would result in a false return, but must additionally establish that tax fraud was in fact the objective of the allegedly criminal conduct.

The statute of limitations for the crime of aiding or assisting the preparation or presentation of a false return or other document is six years. The statute of limitations for charges involving delivery or disclosure of a false document starts to run from the date the document is disclosed or submitted to the IRS.

Examples of Recent Convictions of Practitioners for Tax Crimes:

 

In R.J. Ruble, DC N.Y., 2009-2 ustc, a well-known attorney with the law firm of Sidley, Austin Brown and Wood was convicted of income tax evasion for designing and marketing a tax shelter. The government proved that attorney either knew or alternatively consciously disregarded the fact that the tax shelter he designed and marketed lacked economic substance. There was no business purpose to employ the shelter other than to obtain a tax benefit, and that there was no reasonable probability that the shelter would result in any profit apart from the anticipated tax benefits.  He is currently living in a Federal Penitentiary in Lewisburg Pennsylvania and was sentenced to 78 months without the possibility of parole except that it is possible he may serve the last six months in a half-way house or home confinement.

The following BDO Seidman personnel were sentenced for their role in promoting a tax shelter. Patricia Hurtado, an Ex-BDO Seidman Executive was sentenced to 16 months, Charles Bee, the former Vice Chairman of BDO received 16 months, Adrian Dicker, former Vice Chairman of BDO received 10 months and Robert Greisman, a former partner at BDO received 3 months.  All of these sentences were the results of plea bargains and involved cooperation in the prosecution of other related tax shelter promoters the most prominent of which is Paul Daugerdas, out of the Chicago office of the now defunct law firm of Jenkens & Gilchrist.

The reason that a disreputable minority of Accountants and Attorneys risk promoting tax shelters is crystal clear – Greed!  Most partners of law firms and CPA firms are limited to the amount of profit that can make by selling the time and the expertise of themselves and their staff.   Tax shelters are a commodity that can be sold and rapidly replicated in cookie cutter fashion and the profit potential is completely unrelated to the time necessary to provide the services but rather relates more closely to a piece of the tax savings generated by the scheme typically ranging from 3 to 5 % on average.

For example Mr. Bee earned an estimated $23.6 million in fees as a result of promoting tax shelters and is purported to have encouraged other professionals at BDO to do the same even though he’s currently portrayed as part of a rogue group by his old firm.  Paul Daugerdas generated $95 million in fees from the creation and marketing of tax shelters while simultaneously paying less than $ 8,000 in federal taxes when he in actuality owed more than $32 million in federal tax.

Additionally, the sentencing can occasionally seem light when compared to the financial damage done to the federal and state tax systems.   For example, Mr. Bee only received a 16-month sentence because of evidence and cooperation he provided on Paul Daugerdas (a much larger fish in this example).  The judge was quoted as stating that while he found Bee’s testimony to be credible and his cooperation significant, “it doesn’t change the fact that he helped perpetrate one of the largest tax frauds in the history of the United States.” Daugerdas, (a lawyer and certified public accountant by the way) created and selectively marketed tax shelter schemes named “Short Sales,” “Short Options Strategy,” “Swaps,” and “Homer” that produced $7 billion in fraudulent tax deductions for approximately 1,000 of the mostly wealthy clients of his and a handful of prominent public accounting firms and more than a billion dollars’ worth of sham losses. A report conducted by a consulting firm commissioned by the IRS estimated that illegal tax shelters cost the government between $ 14 and $ 18 billion in lost federal tax revenue in 1999 alone.

While Mr. Bee’s sentence may appear light, the federal government must send out the message that crime does not pay. To that end Paul Daugerdas was convicted and sentenced to 15 years for conspiring to defraud the IRS, aiding and abetting income tax evasion, mail and wire fraud and other crimes. He was ordered to forfeit $164,737,500 in proceeds traceable to his offenses and certain assets were seized including a lakefront home on Lake Geneva in Wisconsin, roughly $20 million in various securities and miscellaneous financial accounts and he was ordered to pay $371,006,397 in restitution to the IRS.

Currently, I suspect that a new generation of greedy tax lawyers has most likely again crossed the line and are covertly working behind closed doors with tax shelter “promoters” that include prominent public accounting firms, investment banks, and insurance companies, to create and selectively market new varieties of tax shelters. While I expect, they are still, as in the past, a minute minority of the Tax Bar, their numbers are likely to have grown dramatically since the government has moved its focus offshore. Today as in the past they most likely occupy prominent positions at prominent firms.  With the government’s focus on offshore evasion the exposure is probably perceived to be even lower than it was seen to be in the late 90’s and I expect that when the government returns their attention to onshore evasion the next round of investigations and prosecutions will fruitfully ensue.

Exposure of Tax Practitioners to Tax Crimes:

 

Both the federal and state taxing authorities can bring both felony and misdemeanor tax charges against Tax Attorneys, CPAs E. A.’s, tax preparers and their client, the most common of which include tax evasion, failure to file a return or pay tax and filing a false return. The IRS also prosecutes taxpayers under the Federal Criminal Code on charges such as presenting false claims to the government, conspiracy, and making false statements.

In order for the federal government to prevail in a criminal prosecution, they must prove each element of an accused tax crime beyond a reasonable doubt. Moreover, the Government must bring the action within the appropriate statute of limitations for prosecution that range from three years to six years under the internal revenue code and within five years for crimes prosecuted under the Federal Criminal Code.

To complicate matters further, individuals can be convicted of committing a tax crime with regards to another person’s or entities tax liability, like for example, where a corporate officer falsifies the associated corporate returns. Corporations and other legal entities such as Estates, LLC and Partnerships may also be prosecuted. Thus, CPA’s should be aware of their own potential liability for tax crimes in preparing returns such as aiding and abetting the commission of an offense or conspiracy to commit tax evasion.  The federal government has recently endeavored to expand the definition of a preparer to extend to anyone that provides advice or an opinion as to a position taken on a tax return which should be of great concern to Tax Attorneys.

Any person who is required to keep any records or supply information and who willfully fails to do so can be convicted of a misdemeanor. A person who willfully delivers or discloses to the Treasury Secretary (or his or her delegate) a list, return, account, statement, or other document that the person knows to be fraudulent or false as to any material matter can be convicted of a misdemeanor.

In doing representation, planning and compliance work Tax Practitioners should be especially aware of the legal definitions of Obstruction and Aiding or Assisting a False Return.

Obstruction

The crime known as “tax obstruction” is found in IRC § 7212, which actually lists several crimes. However, there is one clause in this statute—known as the “Omnibus Clause”—that is the focus here. An Omnibus Clause violation exists when someone (anyone) “in any way corruptly . . . obstructs or impedes, or endeavors to obstruct or impede, the due administration” of the tax laws. § 7212.

To establish a Section 7212(a) omnibus clause violation, the IRS must prove three elements beyond a reasonable doubt: (1) that the defendant made a corrupt effort, endeavor, or attempt (2) to impede, obstruct, or interfere with (3) the due administration of the tax laws (Internal Revenue Code). U.S. v. Wood, 384 Fed. Appx. 698 (10th Cir. 2010).

Aiding or Assisting a False Return

The crime known as “aiding or assisting a false return” is codified in IRC § 7206(2), which essentially makes it a felony for someone to “willfully aid . . . assist, procure, counsel, or advise” someone in the preparation of a document (e.g. a tax document) that is “materially” false.

Broken up into its elements, the government must prove five things, each one beyond a reasonable doubt: (1) the defendant aided, assisted, procured, counseled, or advised another in the preparation of a tax return (or another document in connection with a matter arising under the tax laws); (2) that tax return (or other document) falsely stated something; (3) the defendant knew that the statement was false; (4) the false statement was regarding a “material” matter; and (5) the defendant aided, assisted etc. another willfully (that is, with the intent to violate a known legal duty).

One thinks here of a CPA, enrolled agent, or other tax preparer who is trying to help his or her client pay less tax, but that person (the taxpayer himself or herself) was not involved in the tax preparation process. But the tax crime of aiding another to prepare a false document captures more than just CPAs and enrolled agents. It includes anyone who prepares false documents—for example, an appraiser who values a business interest for tax purposes, or a tax shelter promoter. An appraiser might have to discern the value of a partial interest in a business or other asset contributed to a charity. An inflated value would achieve a higher charitable deduction to the taxpayer, but if that value is not defensible, the appraiser could be charged with “aiding in the preparation of a false return” under § 7206(2).

The basis for aiding and abetting violations is accomplice liability. An individual may be indicted as a principle for committing a substantive offense upon a showing of him or her to be an aider or abettor. In practice this means persons who have aided and assisted another in tax evasion by concealing another person’s sources of income or assets. To prevail in bringing a charge under the federal aiding and abetting statute, the government must prove beyond a reasonable doubt that:

A substantive criminal offense was committed.

The defendant, by affirmative conduct, participated in, counseled, or assisted in the commission of the substantive offense.

The defendant shared with the principal the criminal intent to commit the substantive offense.

An accused must associate themselves in some manner with a criminal venture to be convicted of aiding and abetting the commission of an offense. This is established by a showing of participation in the criminal venture that demonstrates a desire to seek and bring about the criminal result. However, the aider and abettor need not perform the substantive offense nor even know its details to be convicted or even be present when the offense is committed. To be successful in bringing an action for aiding and abetting, the government need only show that the defendant intentionally assisted in the commission of a specific crime in some substantial manor.

In order to sustain a conviction, the government must present evidence showing an underlying offense, this means aiding and abetting is not an independent crime. However, the principal who was aided and abetted does not need to be identified or convicted for the government to convict the party accused of aiding and abetting. Moreover, an outright acquittal of the principal will not bar the prosecution of the aider and abettor. Because the aiding and abetting statute does not create a separate offense, the applicable statute of limitations for bringing an aiding and abetting charge is the same as that of the underlying substantive crime that is at issue.

Conclusion

After 20 years as a tax practitioner, I’m amazed at how many shades of grey there appear to be depending upon the point of view of the observer.  Unfortunately, how dark or light a shade of gray is often in the eye of the beholder. I have heard it said that like one man’s tax avoidance is another man’s tax evasion which is invariably affected by which side of the fence the beholder sits on (the government’s or the Tax Profession).  Through the drafting of this paper I’ve come to the conclusion that tax evasion is a lot like the Supreme Court’s holdings on pornography – the government knows it when they think they see it!  In the end the exposure of being on the wrong side of this determination can be a career ender and thus the prudent Tax Practitioner should endeavor to use an abundance of caution, generous amounts of due diligence and common sense in order to avoid “to good to be true” tax planning arrangements like the plague.   A practitioner with a developed sense of smell should be able to detect the odor coming from sham transactions and with ordinary due diligence avoid the life altering consequences encountered by Mr. Bee and Mr. Daugerdas.

Former Hollywood Palms Owner Pleads Guilty to Tax Evasion, Financial Fraud

Ted E.C. Bulthaup III is the former owner of both the Hollywood Boulevard and Hollywood Palms theaters. Bulthaup pleaded guilty to tax evasion and financial fraud charges due to mistakes and untenable positions he had taken with the business. At the outset, Bulthaup faced more than 100 indictments charging that he engaged in activities including mail fraud, wire fraud, and sales tax fraud. The plea deal resulted in the dismissal of most of these charges.

During 2010, 2011 and 2012, Bulthaup “caused partnership income tax returns for Naperville Theater LLC, doing business as Hollywood Palms, to be created.” During this period of time, Bulthaup allegedly engaged in an array of fraudulent conduct. Prosecutors charge that Bulthaup both overstated and understated his income. As far as overstating his income, Bulthaup inflated sales and gross receipts on fraudulent tax documents to secure business loans. Regarding the understatements of income, prosecutors claimed that Bulthaup failed to report and pay taxes on more than $18 million in revenue generated between 2009 and 2013.

What Penalties can the Former Business Owner Face for His Tax Fraud?

Originally, Bulthaup faced more than 100 criminal charges. The plea agreement he agreed to dismissed these other charges and resulted in Bulthaup facing only two criminal charges. First, Bulthaup faced a single count of sales tax evasion. Sales tax evasion charges are appropriate when an individual or business endeavors to defeat the assessment of sales taxes or endeavors to defeat the payment of the sales taxes after a valid assessment has occurred. Under the Illinois state law that Bulthaup pleaded guilty to violating, he could face between four to fifteen years in prison for the sales tax fraud.

Bulthaup also faces charges related to his fraudulent loan activities. Due to intentionally presenting fraudulent tax returns and financial information to secure a loan, Bulthaup also pleaded guilty to a single count of financial institution fraud. In this case, financial institution fraud can be punished by a prison sentence of between three and seven years.

However, the situation could have been significantly worse for Bulthaup. While he could end up serving a maximum of 22 years under the plea deal, the hundreds of charges he originally faced would have almost assuredly resulted in more prison time. Business owners who consider engaging in sales tax or payroll tax fraud should understand that they can face significant and life-altering consequences due to behavior of this type.

Bulthaup will be sentenced Oct. 26, 2016, by Judge Daniel Guerin.

CFO Sentenced to Prison for Tax Evasion and Check Kiting

According to court documents, Brian M. Quimby was employed as the CFO for Thayer Power and Communications. During his tenure as CFO, Mr. Quimby engaged in a scheme known as check kiting. Check kiting is a well-known and long-established for of check fraud, but due to the inherent nature of how checks work, it is difficult to detect such a scheme until a sufficient number of transactions have been completed or until the scheme begins to unravel. However, essentially, a check kiting scheme is a type of financial fraud where a check is transformed from a method of exchange – a negotiable instrument – to an unauthorized loan. That is, the check is written for an amount where the account it is drawn against has insufficient funds to cover the check. While this would normally trigger a message for non-sufficient funds (NSF), an individual engaged in a kiting scheme will falsely inflate the perceived balance of the account by writing a check from a second account to cover the draw on the first account. While there are many variations of the check kiting fraud, this captures the essential elements of the fraud.

In any case, Mr. Quimby engaged in a check kiting scheme that defrauded Thayer Power and Communications and Key Bank. Mr. Quimby also failed to file income taxes in 2007 – likely in an attempt to conceal his fraudulent income gained through the check kiting scheme. Despite knowing that he had not filed taxes, Mr. Quimby apparently lied to an IRS agent stating that he did file. Mr. Quimby was sentenced to a 27-month federal prison sentence. Furthermore, the court ordered him to repay $202,789 to Thayer and nearly $90,000 to the IRS.

Dual Suicides by Execs Involved in Payroll Tax Fraud Matter

One executive had an ownership interest in the company and was CFO. The other executive was co-owner and sever as the company’s chief operating officer (COO).  Tragically, both executives of SPG took their lives just one week apart and after both had been working with the IRS Criminal Investigation division. Toby Steven Fanning was found dead in his backyard in an apparent suicide. Philip Edward Lawrence was found dead at a cemetery near Lenoir City Park due to a shotgun blast. The impetus for the men’s apparent suicides? An alleged payroll tax scheme that prosecutors claim was masterminded by the CEO of Service Provider Group (SPG), Zebbie Joe Usher III. According to allegations found in court records, Fanning, Lawerence, & Usher, would sign up client companies for SPG’s payroll services business. But, rather than holding payroll tax funds in trust for the client companies, prosecutors allege that the three would skim money that SPG was supposed to pay over to the U.S. government. To hide their alleged misdeeds, prosecutors claim that the three engaged in a systematic underreporting of payroll taxes owed by clients for the first three-quarters of the year, and then inflated fourth-quarter payroll taxes to conceal the underpayment. By the time authorities detected the scheme, approximately $29,174,931.87 in payroll tax losses had already been incurred. Usher’s sentencing, originally slated for January, is now scheduled for July 9th.

Texas Tax Preparer Pleads Guilty to Fraudulently Preparing Tax Return

According to a press release by the Department of Justice, Texas tax preparer Chester Swanson pleaded guilty to a single count of preparing a false U.S. individual tax return. The guilty plea was part of a deal reached with federal prosecutors. Additionally, Swanson will pay restitution to the IRS and agreed not to prepare tax returns for taxpayers again.

 

According to court documents, Swanson owned and operated Chester’s Mobile Tax Service and served taxpayers throughout Texas. Prosecutors alleged that Swanson secured his clients improper refunds by inflating deductions such as medical expenses and donations to charity. Department of Justice officials estimated that Swanson’s illegal activity resulted in a tax loss of approximately $244,000, an amount that will be repaid in restitution as a part of the plea deal.

 

Understanding Tax Preparer Fraud

 

U.S. tax law places special responsibilities on those who prepare tax returns for others. Contrary to popular understandings, any person who prepares a tax return for compensation is a tax preparer. Thus, a family friend who is not a CPA or tax attorney that prepares a tax return in exchange for a de minimis compensation, such as lunch, is a tax preparer and can be criminally prosecuted if purposeful misstatements that typically understate taxable income are included on a filed tax return.

 

Even if a tax preparer is presented factually incorrect information that is used to prepare the return, he or she may still be criminally and civilly liable for aiding another in the commission of tax fraud if the preparer knew or had reason to know that the information was false. For example, if the tax preparer asks a taxpayer how much he gave to charity in the prior tax year and the taxpayer responds with “I don’t know, I’ll just make up a number”, the resulting charitable deduction could have been based on information that the preparer knew was fraudulent.

tax preparer can be convicted if he or she makes a false material misstatement on a prepared tax return. Whether a misstatement is material is determined based on the type of information that was false rather than whether the misstatement caused the federal government a revenue loss.

Michigan Real Estate Professional Sentenced on Tax and Bank Fraud Charges

A real estate businessman from Michigan was sentenced to spend a year and a day behind bars for tax and bank fraud. According to a press release by the Department of Justice, Richard Pierce engaged in the filing of false tax returns for the tax years between 2004 and 2013.  Within those returns, he failed to report more than $9 million of gross business income that would have led to a tax bill of over $400,000. The omitted income stemmed from several real estate businesses that Pierce controlled including Phoenix Real Estate Company, Phoenix Preferred Properties LLC, Detroit Matrix, First Metro Properties LLC, and RFP Ventures LLC. Through the government’s investigation of Pierce’s affairs, government law enforcement officials determined that Pierce committed bank fraud by falsely disclosing a kickback on an application to a mortgage lender. Pierce pleaded guilty to the charges in February of 2015.

 

In addition to spending over a year in prison, Pierce will spend two years under supervised release and will be required to pay restitution to the IRS. The financial sanctions against Pierce will be determined at a later court date.

 The IRS Is Targeting Captive Tax Shelter Abuse as it Announces New Enforcement Initiative

 

What Are Captives and Micro-Captives?

A micro-captive is a type of captive entity where annual premiums are less than $1.2 million. As suggested in the foregoing, this means that captives and micro-captives are typically a type of insurance company entity organized under Internal Revenue Code § 831(b). Under § 831(b), a captive must meet the following standards:

  • The captive must have adequate risk-shifting, be operated like a bona fideinsurance company, and have adequate capitalization.
  • The entity must make a proper tax election under section 953(d) of the Tax Code.
  • To qualify as a micro captive, the gross premium income for a tax year must be less than $1.2 million.

When a taxpayer utilizes a micro-captive, he or she can reap certain tax benefits because the entity’s premium income is not subject to tax. The entity pays tax only on investment income.

While the tax benefits are clear, there is significant room for mistakes and errors. For one, some tax minimization firms will recommend for taxpayers to reduce their taxes by emphasizing the mathematical $1.2 million threshold and deemphasizing or omitting other important requirements. Setting up a “paper” captive or micro-captive that exists only to leverage the tax benefit, will attract the attention of the IRS and will often lead to an audit or other tax enforcement action.

 

IRS Is Focusing on the Abuse of Captives and Micro-Captives

Recently, a representative from the IRS indicated that the agency is looking into taxpayer use of captives and micro-captives as illegal tax shelters. Alexis MacIvor, insurance branch chief in the IRS’s Office of Associate Chief Counsel stated that the organization is in the process of cataloging and analyzing transaction data to determine the level of abuse involving captives. He states that the organization is keeping its options open and, “At the end, we may remove the transaction as a transaction of interest. We may make captive’s a listed transaction. We may do a combination of a listing notice and a transaction of interest.”

While the representative took a diplomatic approach to the issue, in light of the IRS’s past recent actions, it is far more likely that captives will face additional scrutiny in the upcoming months and years.

In 2016, the IRS seemed to acknowledge that an issue existed regarding taxpayer use of captives when it released Notice 2016-66. This notice made micro-captives reportable transactions. This IRS action came on the heels of micro-captives being featured in the IRS’s “Dirty Dozen” tax scams list for the last several years.

The IRS has already indicated that the Office of Tax Shelter Analysis is reviewing and analyzing the thousands of reports from micro-captives the agency has already received. Initial reviews are concentrated on ensuring that forms are accurate and complete. The IRS has already put taxpayers on notice that incomplete or inaccurate forms may be forwarded to the Large Business and International Division examination team. This team will determine whether penalties are appropriate for incomplete disclosures. In any case, it is clear that the IRS is paying attention to this commonly abused tax shelter.

How Do You Report Suspected Tax Fraud Activity?

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If You… Then And
… suspect or know of an individual or a business that is not complying with the tax laws on issues such as:

·         False Exemptions or Deductions

·         Kickbacks

·         False/Altered Document

·         Failure to Pay Tax

·         Unreported Income

·         Organized Crime

·         Failure to Withhold

Use Form 3949-A,
Information Referral

CAUTION: Do NOT use Form 3949-A to report the issues below

Print the form and mail to:

·         Internal Revenue Service

·         Fresno, CA 93888

 

or, order the form by mail or by calling the Tax Fraud Hotline recording at 1-800-829-0433. Note: we don’t accept alleged tax law violation referrals over the phone.

 

You may also send a letter to the address above instead of using Form 3949-A. Please include as much information as possible, such as these important points:

1.       Name and Address of person or business you are reporting

2.       The individual’s social security number or the business’ employer identification number

3.       A brief description of the alleged violation(s), including how you became aware or obtained information about the violation(s)

4.       The years involved

5.       The estimated dollar amount of any unreported income

6.       Your name, address and telephone number*

 

*Although you are not required to identify yourself, it is helpful to do so. Your identity will be kept confidential.

 

Note: Submitters of Form 3949-A will not receive a status or progress update on the referral due to tax return confidentiality under IRC 6103.

…suspect someone stole your identity and used your SSN for employment purposes or could use your SSN to file a tax return Use Form 14039*

 

*Spanish version: Form 14039 (SP)

Complete the form online, print it and mail or fax to the appropriate office using the options listed on page 2 of the form. Include photocopies of at least one of the documents listed on the form to verify your identity. For additional information, refer to the Taxpayer Guide to Identity Theft
…suspect fraudulent activity or an abusive tax scheme by a tax return preparer or tax preparation company Use Form 14157**

 

**Form 14157-A (see below) may also be required

You may complete the form online, print it and mail it to the IRS address on the form.

 

…suspect  a tax return preparer filed a return or altered your return without your consent and you are seeking a change to your account Use Form 14157

AND

Form 14157-A

Send BOTH forms (Form 14157 and Form 14157-A) to the address shown in the Instructions for Form 14157-A.
…suspect an abusive tax promotion or promoter Use Form 14242 The form can be mailed or faxed to the IRS address or fax number on the form.
…suspect misconduct or wrongdoing by an exempt organization or employee plan Use Form 13909 Mail it to the address provided on the form.
…have information and want to claim a reward Use Form 211 Mail it to the address in the Instructions for the form.
…suspect you received or are aware of fraudulent IRS

e-mails and websites

Please let us know! See our Phishing web page.

 

The Office of Professional Responsibility (OPR) At-A-Glance

VISION:

To be the standard-bearer for integrity in tax practice.

 

MISSION:

Interpret and apply the standards of practice for tax professionals in a fair and equitable manner.


Objectives:

OPR’s vision, mission, strategic goals and objectives support effective tax administration by ensuring all tax practitioners, tax preparers, and other third parties in the tax system adhere to professional standards and follow the law.

OPR’s goals include the following: (1) Increase awareness and understanding of Circular 230 and OPR through outreach activities, (2) Apply the principles of due process to the investigation, analysis, enforcement and litigation of Circular 230 cases and (3) Build, train and motivate a cohesive OPR team.

 

 

 

 

 

 

 

CPA Malpractice Claims: CPA Responsible to Detect Fraud

By Craig L. Greene 

In my last article on CPA malpractice, I discussed the CPA’s responsibility to detect fraud. The views taken on fraud detection will vary greatly depending on who is asked. It is very common for the auditor to be convinced that fraud is not their primary duty. On the other hand, the general public often assumes that if a company’s financial statements have been audited, then they can be relied upon and are free of fraud. These opposing views are commonly referred to as the expectations gap. When a fraud is discovered whether it is the CFO overstating revenues or the bookkeeper embezzling from a small business, the victims often assert a malpractice claim against the CPA firm.

Malpractice claims against CPA firms are widespread which is why they carry large professional liability insurance. The fact of the matter is that signing a report carries a large burden that requires a CPA to strictly adhere to the professional standards that are set forth by various governing bodies.

As previously discussed last month, there are two governing boards that oversee auditors and set standards for CPA professionals. The PCAOB oversees the audits of public companies and the AICPA serves all other engagements. Both boards use the term Statements on Auditing Standards (SASs) as the actual standards number. The AICPA uses “AU-C” as the section indicator while the PCAOB uses the “AU” indicator. The AICPA also governs any review, compilation or tax engagements, which are represented by sections “AR” and “TS.”

The standards that determine the auditor’s responsibility in fraud detection are AU Section 316 (PCAOB) and AU-C Section 240 (AICPA), Consideration of Fraud in a Financial Statement Audit. In this article, I will discuss both of those standards, as well as the responsibility of the CPA in performing services in taxation and review and compilation engagements.

Fraud Detection in Financial Statement Audits

The PCAOB and AICPA state that the auditor’s responsibility is “to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.” While this statement would insinuate that detecting fraud is the responsibility of the CPA, it is not possible for an auditor to obtain absolute assurance that the financial statements are not misstated. Therefore, even an audit that is performed in accordance with standards set forth by the AICPA and PCAOB may not uncover fraud or even material fraud despite complying with generally accepted auditing standards (GAAS) due to unreliable evidence and false source documents that have been covered up through layers of collusion.

GAAS addresses the importance of maintaining professional skepticism throughout the engagement. It is easy for a CPA to trust the integrity and honesty of a company that they have been engaged with for a long time. The AICPA acknowledges that an auditor cannot literally question each piece of evidence that is presented and therefore, the auditor may “accept records and documents as genuine” if there is no evidence to the contrary.

Both sets of fraud standards characterize fraud into two categories: (1) misstatements arising from fraudulent financial reporting and (2) misstatement arising from misappropriation of assets. A misstatement from financial reporting is intentional and may be done by manipulating, falsifying, misrepresenting or omitting and intentionally misapplying accounting principles. Misappropriation of assets is also known as theft or defalcation that are material enough to cause the financial statements to not be presented in conformity with generally accepted accounting principles (GAAP).

Secondly, the auditor is required to discuss the issue with an engagement team. The AICPA requires that a partner be included in the discussion as well any key engagement team members. There is no limitation as to which team members are included but it is essential that even those members not included are filled in on the discussions highlights. The discussion should focus on where the entity is susceptible to fraud. This brainstorming session “should occur setting aside beliefs that the engagement team members may have that management and those charged with governance are honest and have integrity.”

In order to further address fraud risk, the next step the auditor will need to take, is to perform a risk assessment of the entity. The first step in establishing an assessment of risk is making inquiries of management. The inquiry should also include any others who are charged with governance including the internal control department if there is one.

After the management inquiries, the auditor is required to identify and assess the risks of material misstatement due to fraud just as they would for every account on the trial balance. These are considered the analytical procedures.

The auditing standards require an auditor to presume that fraud exists in revenue recognition and therefore has the obligation to evaluate the revenue activities, transactions and assertions of the entity. Audit documentation must be kept if the auditor concludes that the presumption of fraud is not applicable to the engagement and therefore revenue recognition is not considered as a risk of material misstatement due to fraud. If there are risks that are assessed, they should be considered significant and the internal controls of the entity should be scrutinized.

Fraud Detection for Performing Review Services

A review engagement is when the CPA is engaged to provide the user with some level of comfort that the accountant is not aware of any material modifications that need to be made to the financial statements of a privately held company. In a review, the accountant will provide the client with limited or negative assurance that material misstatement due to fraud or errors do not exist. Limited assurance indicates that nothing has come to the CPA’s attention, whereas during an audit, the CPA will provide reasonable assurance that the financial statements are in conformity in all material respects.

 

Fraud is addressed in AR Section 90 of the AICPA standards. The first thing that an accountant should understand is that management is the one responsible for fraud prevention and detection. It is also true that a review engagement cannot be relied upon in detecting fraud or errors. Actual performance standards of the AICPA require the accountant to start with inquiries of management specifically related to fraud, including their knowledge of fraud or suspected fraud involving management or other persons.

A CPA is required to receive a written representation letter from management that shows “management’s acknowledgement of its responsibility to prevent and detect fraud” as well as any “knowledge of any fraud or suspected fraud affecting the entity involving management or others where the fraud could have a material effect on the financial statements, including any communications received from employees, former employees or others.”

The accountant will need to document any responses to inquiries of management as well as all analytical procedures performed including, in this case, those that are related to fraud.

Fraud Detection for Performing Compilation Services

During an engagement in which the CPA is compiling financial statements of a privately held business there is almost no concern of fraud. The accountant is not required to perform any analytical procedures or inquiries as it would in a review engagement. There is a requirement to gain an understanding of the industry and that the financial statements are clear of any obvious errors. No opinion is rendered or assurance as to the fair presentation of the compiled statements is given.

In the case that fraud is discovered or that documentation is incomplete or unreliable due to fraudulent activity, the CPA should consult with management about the effects of the issues. If there is a suspicion of materially misstated items due to fraud, then the CPA should request additional information. If the entity refuses, it is the accountant’s duty to withdraw from the engagement and document the decision.

Fraud Detection for Providing Services in Taxation

Claims brought against CPAs for malpractice occur most frequently when the engagement was for tax services. While the lawsuits are not always as lucrative, in terms of dollar amounts, the total number of cases brought against tax preparers is high. The easiest claim a taxpayer can make against a CPA is when the preparer makes an error or fails to inform the taxpayer of a past mistake. The AICPA is one governing body that sets standards for CPAs who perform tax services. Specifically, the Statement on Standards for Tax Services No. 6, Knowledge of Error: Return Preparation and Administrative Proceedings, (SSTS No. 6) is the written standard that will guide the tax preparer as to what steps should be taken when there is an error on the tax return.

SSTS No. 6 defines the three types of situations that the standard addresses. They are as follows:

  • An error in a taxpayer’s previously filed tax return.
  • An error in a return that is the subject of an administrative proceeding, such as an examination by a taxing authority or an appeals conference.
  • A taxpayer’s failure to file a required tax return.

Once a tax preparer finds an error, it is important that they inform the client of the error. Paragraph 7 of SSTS No. 6 requires the tax preparer to give notice as well as recommend the appropriate steps taken to correct an error. The tax preparer may give such advice over the phone or in person, but I recommend it be made in writing. When facing malpractice lawsuits, it is important to prove that there was no negligence and that is was essentially the taxpayer’s decision to forego correcting the error. A memo sent to the client regarding the error, as well as their response should be sufficient to document the requirement to inform the taxpayer.

In the end, it is the taxpayer who is responsible for deciding whether or not to fix an error and amend a return, not the tax preparer. Therefore, if the taxpayer goes the route of not correcting an error, the tax preparer should consider withdrawing from the engagement. Keep in mind that it is not required that the CPA withdraw from the engagement. Tax standards require the tax preparer to confirm that if they do not withdraw from an engagement in which an error does not get amended, then they must confirm that it will not carry forward to the next year. Tax standards also require the preparer to disclose any “erroneous” accounting methods that are used by the taxpayer.

Conclusion

The idea that a CPA malpractice claim can happen to any firm that engages in accounting is not a false one. The CPA profession has a high exposure to lawsuits and liability for a multitude of reasons.

Craig L. Greene is a founding partner of McGovern & Greene LLP a forensic accounting and litigation services consulting firm. He is a CPA, certified in fraud examination, financial forensics, corporate compliance and ethics and a master analyst in financial forensics. He works as a consultant and expert witness on complex financial matters including allegations of financial fraud, CPA malpractice, shareholder and partner disputes and many other forensic accounting related matters. Craig is the former regional governor and president of the Greater Chicago chapter of the Association of Certified Fraud Examiners and an internationally recognized speaker on fraud and fraud examination. For more information, please visit www.mcgoverngreene.com.