Treacherous Terrain of Tax Preparation Requires Strongest Ethics

Increasingly knotty tax laws and stringent enforcement efforts are making ethical and knowledgeable tax preparation more important than ever. As tax professionals strive to navigate the complexities, completing a simple tax return may conceal unforeseen risks.

A tax professional’s understanding of the requirements of due diligence can reveal how seemingly innocent mistakes contain the potential for tax fraud or evasion, which could lead to legal problems.

Those shouldering the responsibility of accurately filing or assisting clients with filing tax returns bear a weight of this responsibility beyond ensuring mere accuracy. The gravity of this obligation can’t be overstated, especially considering that over 90% of cases referred to the IRS Criminal Tax Division originate from the shortfalls of a tax professional’s due diligence.

As regulatory scrutiny intensifies, the distinction between inadvertent errors and intentional misconduct becomes increasingly critical. The obligation to exercise due diligence serves as a shield against looming threats of tax fraud and invasion. Some cases include:

• Failing to pose pertinent questions during a due diligence interview when a taxpayer applies for specific credits
• Deliberately omitting a portion of a taxpayer’s income, despite the tax professional’s awareness of additional earnings
• Submitting an inaccurate tax form by tax professionals, such as errors in an employer’s quarterly tax returns—including with the employee retention credit
• Allowing employees of a tax professional to misappropriate client tax refunds
• Assisting a taxpayer in evading taxes, exemplified by creating a scam to help individuals circumvent tax payments or defraud the IRS

Pitfalls in Pursuit of Refunds

Tax professionals can jeopardize their professional standing, as well as put their clients at risk of legal problems, by bypassing due diligence in the relentless pursuit of maximizing client refunds. This choice often involves overlooking critical aspects related to tax credits, deductions, and filing statuses.

What might seem like a shortcut to financial gains can unfold into a hazardous path fraught with consequences—from triggering audits and investigations to, in severe cases, culminating in imprisonment. Examples of such risky practices include when a tax professional is:

• Aware that a taxpayer lacks a business, yet placing Schedule C (self-employed income tax return) income on the personal return to qualify for specific credits or deduction
• Adding Schedule C expenses on a personal return to offset income so the taxpayer can qualify for specific credits and deductions
• Knowing a taxpayer shouldn’t claim a particular dependent on their returns but allowing the taxpayer to do so to reduce tax liability
• Knowing that the taxpayer doesn’t qualify or have the income to maintain a household, yet categorizing the taxpayer as head of household to generate a higher tax refund
• Preparing tax returns that include fraudulent wage documents

Tax professionals must balance client satisfaction and ethical practice. Neglecting due diligence undermines the integrity of the tax profession and exposes practitioners to tax fraud allegations.

To safeguard their professional reputation and their clients’ interests, tax professionals must thoroughly interview clients to verify eligibility for reported deductions and credits and stay informed about tax laws through continuous education. They also must refrain from helping clients misappropriate government funds and be willing to disengage from clients when necessary.

In adhering to ethical practices, tax professionals fulfill their obligation to due diligence but also contribute to a tax environment built on trust, integrity, and compliance.

Navigating the IRS’s Watchful Eye

The IRS rigorously monitors tax returns through comprehensive compliance programs such as its Discriminant Function System, which scores potential changes based on the agency’s historical experience with similar returns. The IRS also measures whether a payer’s reported return (such as a 1099 or W-2) matches the income or information reported.

The IRS further employs artificial intelligence technology to sift through tax returns. Its AI algorithms are designed to detect anomalies and irregularities, casting a spotlight on the activities of tax professionals.

The IRS uses the Discriminant Function System scoring program to audit taxpayers, but might extend the audit to include the tax professional if there is a discernible pattern among multiple taxpayers who share the same tax professional. This typically involves a paid preparer’s due diligence audits, tax professional’s office audits, and/or criminal investigations.

Tax professionals can ensure that they meet due diligence requirements when preparing, assisting, or approving tax return submissions; having a comprehensive understanding of the tax code; staying compliant with IRS regulations and publications; and safeguarding clients’ records and data.

Outlook

The role of tax professionals remains one of building and maintaining trust, competence, and unwavering integrity, even as tax laws continue to evolve. The IRS consistently modifies tax laws, even during tax season. For instance, the Tax Relief for American Families and Workers Act of 2024 proposes an increase in taxpayers’ child tax credit.

If a tax professional files a tax return but the client qualifies for the increase after the bill’s passage, the preparer may need to amend the return.

The IRS is beta testing its own tax preparation system, allowing taxpayers to complete their returns directly to the agency. This carries the risk of some preparers losing clients, so it’s crucial for tax professionals to build and maintain their clients’ confidence.

Prioritizing education is paramount for fostering a knowledgeable and skilled tax professional community. Safeguarding against unforeseen challenges, such as errors and omissions, through comprehensive insurance policies ensures a resilient foundation for continuous learning and professional growth.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Josie Harris-Walton is tax partner at Quintairos, Prieto, Wood & Boyer.

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