The answers to these frequently asked questions (FAQs) are based on guidance developed by the Statements on Standards for Tax Services (SSTSs) Guidance Task Force in response to questions that were presented during the SSTS public exposure period and since that time in administering the SSTSs. These FAQs are not rules, regulations or official statements of the Tax Executive Committee issued pursuant to its rule-making authority and, therefore, are not authoritative guidance.
The SSTSs should be used in conjunction with these FAQs. The answers to these FAQs may not necessarily address the requirements of the Internal Revenue Service, other tax regulatory bodies and State Boards of Accountancy. These bodies may have rules which differ from those of the AICPA. A member should always consult these other sources to ensure compliance with all appropriate regulatory requirements.
What process should a member use in determining if an error on a tax return is insignificant?
SSTS No. 6 indicates, “However, an error does not include an item that has an insignificant effect on the taxpayer’s tax liability.” The following should be considered:
The amount of the item affected by the error in comparison with the amount of other items on the return.
The effect on taxable income and tax liability.
The effect of the item on prior and future returns. The nature of the item and possible adverse consequences that result from the nature of the item (e.g., interest from a foreign bank account).
Note that Circular 230, §10.21 does not contain an exception for an item with an insignificant effect on the taxpayer’s tax liability.
What should a member do when the member determines a taxpayer's overstated deduction is insignificant versus significant (in the following situation)?
A member is representing a taxpayer during a federal tax examination. The IRS has issued an information document request (IDR) for supporting information on certain deductions claimed on the return under examination. In the process of assembling the information to respond to the IDR, the member has determined a deduction claimed on the return was overstated. What should a member do when the member determines a taxpayer's overstated deduction is insignificant versus significant?
The member has determined the overstated deduction would have an "insignificant" effect on the taxpayer's tax liability. What should the member do?
SSTS No. 6 is not applicable to an item that has an insignificant effect on the taxpayer’s tax liability. Circular 230, §10.21 does not contain an exception for an insignificant effect. Thus, Circular 230, § 10.21 requires the practitioner to advise the client of the facts and consequences of the error.
The member has determined the overstated deduction would have a “significant” effect on the taxpayer’s tax liability. What process should the member follow in determining what to do?
Both SSTS No. 6 and Circular 230, §10.21 require the member to inform the taxpayer of the error and the consequences of such error. SSTS No. 6 indicates such advice may be given orally. Although SSTS No. 7 indicates that oral advice may serve a taxpayer’s needs appropriately in routine matters or in well-defined areas, written communications are recommended in important, unusual, substantial dollar value or complicated transactions. The member should use professional judgment about the need to document oral advice. The member should also consider the provisions of Circular 230, §10.33. For example, in evaluating how the advice should be communicated and documented, the member should consider the client’s understanding of the form and scope of the advice or assistance to be rendered and the need to establish relevant facts and the applicable law which support the member’s conclusions. Additional guidance on a member’s course of action and thought process are indicated in question C below.
The member has determined the overstated deduction would have a “significant” effect on the taxpayer’s tax liability. The taxpayer will not allow the member to disclose the overstated deduction to the taxing authority examiner. What should the member do?
It is the taxpayer’s responsibility to decide whether to correct or disclose an error. If the taxpayer does not correct or disclose an error, the member should consider whether to withdraw from the engagement and whether to continue a professional or employment relationship with the taxpayer. The member’s decision on representing the taxpayer should be based on professional judgment, the facts and circumstances and other applicable standards. The member should specifically consider Paragraph 10 of SSTS No. 6 regarding the potential adverse effect of withdrawal. The member should consider consulting with legal counsel regarding the issue of withdrawal.
There are several standards established in Circular 230 that may be relevant. Consider the member’s responsibility under §10.34(b)(iii) regarding submission of a document that contains information that may be considered an intentional disregard of a rule or regulation. The member also has responsibility under §10.34(c) to inform the client regarding potential penalties that may apply and the possible opportunity to avoid such penalties by disclosure of the error. Circular 230, §10.51(a) defines incompetence and disreputable conduct for which a practitioner may be sanctioned. Under this subsection, various examples of such conduct are listed including paragraph (4): “Giving false or misleading information, or participating in any way in the giving of false or misleading information to the Department of the Treasury or any officer or employee thereof…” .
How should a member prepare the current year's return which includes an incorrect net operating loss (NOL) carryforward, assuming the taxpayer does not want to amend the previous year's return because it would have no tax impact for that year (in the following situation)?
A member is assisting a taxpayer to prepare his federal income tax return. The taxpayer started a business which has lost money for several preceding years and has an NOL carryforward. The current year shows a small amount of profit. While reviewing the taxpayer's prior year federal return, the member notices the taxpayer has erroneously expensed some loan costs that should have been amortized. Correcting the error would reduce the amount of the NOL, but the taxpayer would still be in a position with no net tax effect. When the member informed the taxpayer of the error, the taxpayer said he did not want to amend the previous year's return because it would have no tax impact for that year. How should the member prepare the current year's return with respect to the loan costs previously expensed?
In these circumstances, the member may decide that it is appropriate to continue the current engagement. In that case, the member’s professional obligation is to prepare a correct return for the current year. It may be incorrect to continue currently deducting the loan costs. (Consider whether the deductions would be regarded as a “method of accounting” and, if so, whether pursuant to Regs. Sec. 1.446-1(e)(2)(i) the taxpayer is required to request and secure consent from the IRS before changing a method of accounting.)
If the taxpayer is not required to obtain the IRS’s consent to make the change, the current year return should be prepared as if the returns for the prior years had reflected the correct deductions.
The AICPA’s Statements on Standards for Tax Services (SSTSs) are enforceable tax practice standards for members of the AICPA. Additional guidance is also found in the corresponding interpretations and frequently asked questions (FAQs). Access to the complete set of SSTSs and guidance are available in the AICPA’s Statements on Standards for Tax Services Library.