WebCPA reports that the IRS has issued these 6 tips when choosing a tax return preparer:
- Be cautious of tax preparers who claim they can obtain larger refunds than other preparers.
- Avoid preparers who base their fee on a percentage of the refund.
- Use a reputable tax professional who signs the tax return and provides a copy.
- Consider whether the individual or firm will be around to answer questions about the preparation of the tax return months, or even years, after the return has been filed.
- Check the person’s credentials. Only attorneys, CPAs and enrolled agents can represent taxpayers before the IRS in all matters, including audits, collection and appeals. Other return preparers may only represent taxpayers for audits of returns they actually prepared.
- Find out if the preparer is affiliated with a professional organization that provides its members with continuing education and resources and holds them to a code of ethics.
The authors then add this final comment (emphasis added):
Reputable preparers will ask to see receipts and will ask multiple questions to determine whether expenses, deductions and other items qualify. By doing so, they are trying to help their clients avoid penalties, interest or additional taxes that could result from an IRS examination.
I agree with the six tips, but, for the following reasons, disagree entirely with the author’s contention that tax preparers must examine their client’s original receipts:
- It’s an urban myth that a taxpayer must have receipts in order to claim a deduction. The only requirement for a tax deduction is that it’s true.¹
- A tax preparer is not hired nor is he being paid sufficiently to conduct an audit of the taxpayer’s books and records.
- Tax preparers are advocates for their clients, not for the federal government and cannot be compelled to perform unremunerated services for the latter.²
- A tax preparer should believe that his client is telling the truth unless he has reason to believe he is lying. If he has reason to believe his client is lying, he should terminate the enagement and cease to represent him.
Footnotes:
¹ The examples are myriad. One of the more common ones is where a taxpayer has lost his records from flood, fire or theft. In this case the taxpayer is not prohibited from claiming deductions on his tax return even though it is probably true that were he audited he’d have a hard time proving that he incurred the expense and that the amount he claimed on the return is correct. Furthermore, one of the most famous tax cases in history specifically permits taxpayers to estimate their deductible expenses in the absence of adequate records. See The Cohan Rule: Can a Taxpayer Estimate his Deductible Expenses.
² In cases where the tax preparer knows his client lacks receipts and where estimates are being used as to the actual amounts of deductible expenses, a disclosure statement should be attached to the return as follows:
This return is based on incomplete records. Estimates were used to determine the amount of expenses. Should records or new information become available to the taxpayer at a later date indicating that the information included in this return is materially incorrect, the taxpayer will immediately file an amended tax return to correct this filing.
12 responses so far ↓
1 Mike // Mar 23, 2010 at 10:54 am
Very good post. This is just another example where the IRS is trying to get the tax preparer to do the job of an IRS Revenue Agent.
P.S. I think you mean to say “examine,” the verb(both in the title and in the body), as opposed to “exam,” which is a test.
2 Peter // Mar 23, 2010 at 11:16 am
Mike,
Thanks for the compliment and for catching my errors. I corrected them.
3 Tony // Mar 24, 2010 at 5:17 pm
I don’t know if suggesting that a tax preparer should ask to see a client’s receipts is the same as requiring the preparer to add-up, take a statistical sample or otherwise examine the receipts. For example: if an individual claimed material medical expenses the tax preparer should ask if he has substantiation. The client pulls out a box of receipts and the preparer is satisfied without further examination. If the client has no documentation I would expect the preparer to advise them of an audit risk.
4 Peter // Mar 24, 2010 at 8:13 pm
Tony,
I agree with you that a tax return preparer should tell his clients that if they are audited they will have the burden of proving the validity and amount of their deductions.
But taxpayers do not have a legal obligation to prove anything to their tax preparers. Furthermore, taxpayers are entitled to claim legitimately deductible expenses regardless of whether or not they have receipts.
It is in the IRS’s interest to give taxpayers and their tax preparers the impression that preparers have a duty to perform what is an essentially an audit of the taxpayer’s records prior to the preparation and filing of a client’s return.
No such duty exists.
5 Hnin // Apr 13, 2010 at 9:23 pm
Does preparer need to keep copy of his/her client’s return?
6 Peter // Apr 14, 2010 at 3:32 am
hnin,
He should. And he is also required to give the taxpayer a signed copy of the return.
7 Tony // May 10, 2010 at 8:50 pm
Peter,
Thank you for the explanation. I guess you are correct that a legal duty does not exist.
But it seems to me that in many cases a client (say a small business owner who is paying a fair fee for expertise) should expect some analysis more than plugging numbers into the return. A tax preparer should provide more value than a software program.
8 Peter // May 10, 2010 at 10:21 pm
Tony,
I agree that the client and his accountant can contract for a more diligent preparation process.
But that, of course, will mean a higher fee.
9 IRS Disbars CPA for Relying on Client’s Income and Expense Numbers // Jul 6, 2010 at 7:10 pm
[...] [...]
10 Dianne // Nov 2, 2010 at 6:16 pm
I prepared the books for a small business so he could complete tax returns for a few years he is behind in filing. I itemized each of his income & expense items in a Quickbooks Pro format. I supplied his tax preparer with a complete P&L with an attached item list showing each entry to the penney that went into each category. The tax preparer refused to prepare & sign the return unless I prepare organized folders for each item entered so he can review each receipt & make sure the total receipts, say for fuel, etc, match the total I have listed for fuel, etc, on the P&L. The preparer stated, “I can’t put my name on this return unless I can verify the receipts for each of your deductions”. I have worked with Tax Preparers, accountants & CPA’s for about 30 years & been involved in thousands of tax return preparation & never heard of the preparer demanding to review the bookkeepers receipts. I feel this preparer is upset that he will only be able to charge for the actual income tax preparation & is trying to find a way to generate additional income for something he is not requirred to do. Is it necessary for this preparer to review each receipt this client has to match each deductible category when I have already done that for him & supplied a complete itemized list of each receipt?
Dianne
11 Peter // Nov 2, 2010 at 6:23 pm
Dianne,
He is auditing your books and records rather than merely preparing your tax return. It’s not only not necessary, it’s absurd.
He must charge a fortune for that.
12 Mike // Nov 19, 2010 at 9:48 pm
There are really two issues being discussed here. First, are “receipts” needed for the tax deduction to be allowed? Second, what “duty” does the return preparer have to verify whether the taxpayer(s) have substantiation?
The answer to the first question is the usual: “it depends”. There is obviously more probative value in contemporaneous records (e.g., receipts). It’s much easier to convince an auditor or a judge with receipts. However, is all lost if there are no receipts? The Cohan Rule cited (based on the George Cohan case, Cohan, 8 AFTR 10552, 2nd Cir., 1930) is often used by courts to determine whether business deductions are adequately substantiated. In Cohan, the court ruled that an approximation of business expenses, based on credible evidence other than actual documentation, was enough to sustain a deduction.
Is the Cohan rule allowed for all deductions? In a word, NO. IRC Section 274 prescribes specific and strict documentation requirements for business expenses claimed for travel, meals, entertainment and listed property, which includes vehicles (think mileage logs). In Barton (TC Memo 2005-97), the Tax Court ruled that the Cohan rule cannot be used to estimate automobile, meals or entertainment expenses, and Barton’s deductions were disallowed. Repeatedly, the Tax Court has stated: “Deductions are a matter of legislative grace, and taxpayers bear the burden of proving that they are entitled to any.” (Myrtis Stewart v. Commissioner, TC Memo 2010-184, 8/16/2010). In the Stewart case, the Court’s position on substantiation requirements was stated clearly: “When taxpayers establish that they have incurred deductible expenses but are unable to substantiate the exact amounts, we can estimate the deductible amounts, but only if the taxpayers present sufficient evidence to establish a rational basis for making the estimates. In estimating the amount allowable, we bear heavily upon the taxpayer whose inexactitude is of his or her own making. We may not use the Cohan doctrine, however, to estimate expenses covered by section 274(d).”
Similarly, taxpayers cannot use the Cohan doctrine to substantiate charitable contributions. No deduction is allowed unless the taxpayer has either: (1) bank records, such as a cancelled check or bank statement or (2) written acknowledgement from the charity documenting the donation’s amount and date. [IRC Sec. 170(f)(17)]
Adequate substantiation is required to establish depreciable basis and gambling losses (Rev. Proc. 77-29).
In the State of Oregon, no business deduction is allowed on an Oregon income tax return if the information reporting document(s) (Forms W-2, Forms 1099, etc.) are not timely filed:
“ORS 305.217 When deduction for amounts paid as wages or remuneration permitted. No deduction shall be allowed under ORS chapter 316, 317 or 318 to an individual or entity for amounts paid as wages or as remuneration for personal services if that individual or entity fails to report the payments as required by ORS 314.360 or 316.202 on the date prescribed therefor (determined with regard to any extension of time for filing) unless it is shown that the failure to report is due to reasonable cause and not done with the intent to evade payment of the tax imposed by ORS chapter 316 or to assist another in evading the payment of such tax. [1987 c.843 §2]”
Oregon Department of Revenue auditors have and continue to deny deductions for remuneration that should have been reported on Forms 1099-MISC. The potential loss of deductions for items such as subcontractor expenses, and other similar expenses can be substantial. In light of the expanded federal (and Oregon) Form 1099 information reporting requirements effective for payments after 12/31/2011, it would be prudent for any Oregon income tax preparer to, at the minimum, document when he or she informed the taxpayer(s) of these reporting requirements, and the risk of loss of deductions.
The second issue that has been discussed is whether a tax return preparer has a duty to verify whether the client(s) has substantiation for deductions claimed. All U.S. tax return preparers are subject to standards prescribed in IRC Section 6694. The associated regulations require that “reasonable inquiries” and “appropriate inquiries” be made. From a practical perspective, that may or may not involve looking at receipts “to determine the existence of facts and circumstances required by a Code section or regulation as a condition of the claiming of a deduction or credit.” How comfortable is the preparer in “relying in good faith” on the source of the information? Would a “prudent man” rely in good faith without verification in the same set of circumstances? Reg. 1.6694-1(e) provides that:
“(e) Verification of information furnished by taxpayer or other party
(1) In general. For purposes of sections 6694(a) and (b) (including demonstrating that a position complied with relevant standards under section 6694(a) and demonstrating reasonable cause and good faith under §1.6694-2(e)), the tax return preparer generally may rely in good faith without verification upon information furnished by the taxpayer. A tax return preparer also may rely in good faith and without verification upon information and advice furnished by another advisor, another tax return preparer or other party (including another advisor or tax return preparer at the tax return preparer’s firm). The tax return preparer is not required to audit, examine or review books and records, business operations, documents, or other evidence to verify independently information provided by the taxpayer, advisor, other tax return preparer, or other party. The tax return preparer, however, may not ignore the implications of information furnished to the tax return preparer or actually known by the tax return preparer. The tax return preparer must make reasonable inquiries if the information as furnished appears to be incorrect or incomplete. Additionally, some provisions of the Code or regulations require that specific facts and circumstances exist (for example, that the taxpayer maintain specific documents) before a deduction or credit may be claimed. The tax return preparer must make appropriate inquiries to determine the existence of facts and circumstances required by a Code section or regulation as a condition of the claiming of a deduction or credit.”
Aside from government regulatory requirements, what “duty” does the preparer have to the client to maintain reasonable documentation? What are the client’s expectations? Does the preparer make a policy of specifically addressing these questions in a client engagement letter?
Tax return preparation is somewhat like draining a swamp. You have to focus on what the prime objective is while protecting yourself from crocodiles (government) on one side, and alligators (clients) on the other. If you let your guard down you will get bit. Speaking from experience, it’s not a matter of if you will get bit, it’s a matter of when and how bad will the bite be.
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