Ethics and Responsibilities in Tax Practice
Introduction
Tax practitioners occupy a unique position of trust — they serve clients while simultaneously upholding the integrity of the federal tax system. The rules governing this dual responsibility come primarily from Treasury Department Circular 230, the Internal Revenue Code (IRC), and professional standards issued by the AICPA. Understanding these obligations is essential for every CPA, whether preparing returns, representing clients before the IRS, or providing tax advice.
Circular 230: Practice Before the IRS
Who May Practice Before the IRS
Circular 230 (31 C.F.R. Part 10) establishes who may practice before the Internal Revenue Service and the standards they must follow.
| Practitioner Type | Authorization | Scope |
|---|---|---|
| CPAs | Licensed by state boards | Unlimited practice rights |
| Attorneys | Licensed by state bars | Unlimited practice rights |
| Enrolled Agents (EAs) | Pass IRS Special Enrollment Exam or former IRS employees | Unlimited practice rights |
| Enrolled Actuaries | Enrolled by Joint Board for the Enrollment of Actuaries | Limited to actuarial matters |
| Enrolled Retirement Plan Agents | Pass IRS exam on retirement plans | Limited to retirement plan issues |
| Annual Filing Season Program Participants | Complete annual CE requirements | Limited representation rights |
Practice before the IRS includes all matters connected with presentations to the IRS, such as preparing and filing documents, corresponding with the IRS, and representing a taxpayer at conferences, hearings, and meetings.
Duties and Restrictions of Practitioners
Circular 230 imposes affirmative duties on all practitioners:
- Duty to furnish information: Practitioners must promptly submit records or information requested by the IRS, unless the practitioner believes in good faith that the information is privileged.
- Knowledge of client's omission: If a practitioner discovers that a client has not complied with federal tax law or has made an error in a previously filed return, the practitioner must advise the client promptly of the noncompliance, error, or omission and its consequences.
- Diligence as to accuracy: A practitioner must exercise due diligence in preparing, approving, and filing returns, documents, and other papers relating to IRS matters.
- No unreasonable delay: A practitioner must not unreasonably delay the prompt disposition of any matter before the IRS.
Circular 230 does not require the practitioner to notify the IRS of the client's error — only to advise the client. The decision to amend rests with the client.
Conflicts of Interest
A practitioner may not represent a client before the IRS if doing so creates a conflict of interest. A conflict exists when:
- Representation of one client is directly adverse to another client, or
- There is a significant risk that representation of one or more clients will be materially limited by the practitioner's own interests or responsibilities to another client.
A practitioner may still represent clients with a conflict if:
- The practitioner reasonably believes competent and diligent representation is possible for each affected client.
- Representation is not prohibited by law.
- Each affected client gives informed, written consent within 30 days.
Example: Gies Co. and MAS Inc. are both clients of the same CPA firm. Gies Co. is deducting payments to MAS Inc. that MAS Inc. has not reported as income. The CPA must obtain written consent from both parties before continuing to represent them.
Tax Return Positions and Standards
Standards for Tax Return Positions
A practitioner may not sign a tax return or advise a client to take a position on a return unless the position meets specific thresholds:
| Standard | Threshold | Application |
|---|---|---|
| Realistic Possibility | Greater than 33⅓% likelihood of success on the merits | AICPA standard for all positions |
| Substantial Authority | Approximately 40% likelihood of success | Required for undisclosed non-tax-shelter positions to avoid IRC §6662 penalty |
| Reasonable Basis | Approximately 20% likelihood of success | Minimum threshold; position must be disclosed on the return |
| More Likely Than Not | Greater than 50% likelihood of success | Required for tax shelter positions and reportable transactions |
:::tip Exam Tip
Remember the hierarchy of confidence levels: Reasonable Basis (≈20%) < Realistic Possibility (>33⅓%) < Substantial Authority (≈40%) < More Likely Than Not (>50%). The CPA exam frequently tests which standard applies to which situation.
:::
Due Diligence Requirements
Under Circular 230, a practitioner must exercise due diligence in:
- Preparing or assisting in the preparation of returns and other documents
- Determining the correctness of oral or written representations made to the Treasury Department
- Determining the correctness of representations made to clients regarding tax matters
A practitioner generally may rely in good faith on information provided by the client without independent verification, but may not ignore implications of information known to the practitioner.
Example: BIF Partners provides its CPA with a summary of deductible business expenses totaling $500,000. The CPA notices several personal-sounding items (e.g., family vacations, personal clothing). Due diligence requires the CPA to inquire further about these items rather than simply accepting the client's characterization.
Penalties on Practitioners
Sanctions Under Circular 230
The Office of Professional Responsibility (OPR) may impose sanctions on practitioners who violate Circular 230:
| Sanction | Description |
|---|---|
| Censure | Public reprimand; practitioner retains practice rights |
| Suspension | Temporary loss of practice privileges for a set period |
| Disbarment | Permanent loss of the right to practice before the IRS |
| Monetary penalty | Fines for violations; can be imposed in addition to or in lieu of other sanctions |
Tax Return Preparer Penalties Under IRC §6694
The IRC imposes separate penalties directly on tax return preparers:
| Penalty | Trigger | Amount |
|---|---|---|
| §6694(a) — Unreasonable positions | Undisclosed position without substantial authority, or disclosed position without reasonable basis | Greater of $1,000 or 50% of the income derived by the preparer |
| §6694(b) — Willful or reckless conduct | Willful attempt to understate tax or reckless/intentional disregard of rules and regulations | Greater of $5,000 or 75% of the income derived by the preparer |
The §6694(b) penalty for willful or reckless conduct is assessed in addition to the §6694(a) penalty — not as a substitute. A single return can trigger both penalties.
Example: A preparer at Illini Entertainment files a return claiming $200,000 in fabricated deductions, earning a $3,000 preparation fee. The §6694(b) penalty is the greater of $5,000 or 75% × $3,000 = $2,250 — so the penalty is $5,000.
Best Practices for Tax Advisors
Circular 230 §10.33 sets out best practices for tax advisors, including:
- Communicating clearly with the client regarding the terms of the engagement, including the form and scope of advice to be rendered.
- Establishing the relevant facts, evaluating the reasonableness of assumptions or representations, and arriving at a conclusion supported by law and facts.
- Advising clients regarding the importance of conclusions reached (e.g., whether a transaction has a purpose aside from tax benefits).
- Acting fairly and with integrity in practice before the IRS.
Best practices are aspirational guidelines, not mandatory standards. Failure to comply with best practices alone does not subject a practitioner to discipline under Circular 230.
Other Key Practitioner Responsibilities
Contingent Fees
Under Circular 230, a practitioner generally may not charge a contingent fee for services rendered in connection with any matter before the IRS. Exceptions include:
- Services for examination of, or challenge to, an original return
- Services for a claim for refund or credit filed solely in connection with a penalty or interest assessment
- Services rendered in connection with judicial proceedings
Return of Client Records
A practitioner must, at the request of a client, promptly return any and all records of the client necessary for the client to comply with federal tax obligations. The practitioner may retain copies of the records.
Advertising and Solicitation
Practitioners may advertise and solicit business but must not use false, fraudulent, coercive, or misleading statements. Fee information may be published, but claims of specialization are subject to specific rules.
Summary
| Topic | Key Rule |
|---|---|
| Who may practice | CPAs, attorneys, enrolled agents have unlimited rights |
| Client omissions | Advise the client; do not notify the IRS |
| Return positions | Must meet at least reasonable basis if disclosed |
| §6694(a) penalty | ≥ $1,000 or 50% of preparer income |
| §6694(b) penalty | ≥ $5,000 or 75% of preparer income |
| Conflicts of interest | Allowed with informed, written client consent |
| Circular 230 sanctions | Censure, suspension, disbarment, monetary penalty |
| Contingent fees | Generally prohibited for IRS matters |