Circular 230 Ethics Rules

Circular 230, Regulations Governing Practice before the Internal Revenue Service, applies to all paid tax return preparers. These regulations affect the way tax preparers practice and the decisions they make. Not following the rules and regulations of this important IRS publication has cost many tax return preparers both money and their right to prepare tax returns or give tax advice.

Why the spotlight on Circular 230? Over the last few years, the sanctions for failure to abide by the regulations described in Circular 230 have been dramatically increased. To understand why, we first need to look at the “tax gap.”

The IRS defines the tax gap as the “difference between the amount of tax that taxpayers should pay and the amount that is paid voluntarily and on time.” The tax gap can also be thought of as “the sum of non-compliance with the tax law.” In other words, Congress and the IRS think taxpayers are reporting and paying less tax than they should.

And apparently, Congress and the IRS believe that increasing sanctions on tax return preparers will encourage taxpayers to more accurately report their tax liability.

With the IRS estimating that the current tax gap of $450 billion is statistically unchanged from 2001, Congress wanted to know how many tax return preparers there are and what are their levels of expertise. When the IRS could not answer these questions, Congress instructed the IRS to implement a licensing program and also legislated that all preparers for all tax returns be subject to monitoring by the IRS.

Tax practitioners fall under two separate sets of regulatory rules that can impose sanctions – both civil and criminal penalties. The first set of rules is administered by the IRS. These rules are in the Internal Revenue Code (IRC), Title 26 of the code of federal regulations. Preparer penalties may be assessed against an individual or firm meeting the definition of a tax preparer in I.R.C. §7701(a) (36) and treas. Reg. §301.7701-15.  Preparer penalties that may be assessed under appropriate circumstances include, but are not limited to, those set forth in I.R.C. §§ 6694, 6695, 6701, and 6713, which explain the required  procedures, the rules for collecting revenues,  and the penalties for such issues like understating tax liability.

The second set of penalties is administered by the Office of Professional Responsibility (OPR), which is concerned with protecting the public in matters concerned with the Treasury Department. The OPR receives its authority from Circular 230, title 31, §10. The OPR is concerned not with collecting taxes or the understatement of tax liability, but rather, with protecting the public and with a pattern of behavior on the part of the preparer.

This differentiation between the IRS and the OPR is important, because if violations do not ultimately result in the under-reporting of tax, the IRC does not provide any sanctions.  Alternatively, if there is no willful or reckless intent or gross negligence, then sanctions cannot be imposed under OPR

If, however,  a practitioner is deemed to have been reckless and to have under-reported tax liability, then the practitioner can be found in violation of both sets of rules and subject to sanctions, fines, and imprisonment.

Under prior law, individuals with specific designations were covered under Circular 230 and could represent taxpayers in matters where the IRS questioned or made adjustments to the taxpayer’s tax return or account. These individuals could also represent a taxpayer if the taxpayer wanted to institute an action against the IRS. This was considered “practice before the IRS.” The designations covered by Circular 230 include attorneys, CPAs, enrolled agents, enrolled actuaries, and appraisers.

Assisting a taxpayer in the preparation of a tax return was not considered “practice before the IRS,” however, and therefore not covered by Circular 230. The preparer may be required to sign the tax return, but could not represent the taxpayer before the IRS.

New legislation changed the definition of “practice before the IRS.” Circular 230 §10.2 (4) added language that now includes preparation of a tax return to be covered by Circular 230. Some of the changes apply to everyone authorized to practice before the IRS, and other changes pertain to a group of tax preparers who did not fall under these regulations before the change but are now subject to scrutiny by the OPR.

It’s complicated, but it’s important.

Now, more than ever, paid tax return preparers need to understand and educate themselves so they can avoid sanctions for giving false or misleading information to the IRS or for asserting frivolous positions that do not meet realistic possibility standards. Preparers need to recognize what is considered disreputable conduct resulting from improperly preparing returns, and learn to identify tax fraud schemes.

Join Drake Software for the webinar “Avoid Ethical Violations” that discusses the rules of Circular 230, and see how Administrative Law Judges apply regulations governing practice before the Internal Revenue Service in disciplinary proceedings involving practitioners.

Visit the Drake e-Training Center for additional CPE information, registration, and webinar dates and offerings.

The webinar meets the IRS annual continuing education (CE) requirement for two hours of ethics education.

By Richard Kellner, CPA
Drake Software