The nature of tax practice presents a number of unique ethical issues. Tax practice requires compliance with multiple ethical frameworks. This creates ambiguities and raises complex questions. Courts have even questioned whether certain regulatory frameworks, such as Circular 230, are applicable to certain conduct of attorneys in practice before the IRS.
These ambiguities can leave tax practitioners facing practical questions. This paper provides guidance with respect to some ethical issues and takes a comparative look at the primary sources of ethical rules in this context. Specific scenarios will be provided and analyzed to provide real-world practical examples of a proper response to ethical issues presented in a tax practice.
I. CONFLICTS OF INTEREST IN TAX PRACTICE
A conflict of interest is an ethical issue that every tax professional understands on some level. But the standards imposed by multiple governing frameworks, especially when a professional is subject to each framework, create potential ethical dilemmas in the area of conflicts of interest—specifically when a professional undertakes a multi-party tax representation.
a. ABA Model Rules for Professional Conduct, Conflicts of Interest
Model Rule 1.7 of the ABA Model Rules of Professional Conduct sets out the general conflicts of interest principles for an attorney. Subsection (a) of Rule 1.7 provides that a lawyer cannot represent a client if there is a concurrent conflict. See ABA Model Rules of Professional Conduct 1.7(a). It defines a concurrent conflict as follows:
A concurrent conflict of interest exists if:
- the representation of one client will be directly adverse to another client; or
- there is a significant risk that the representation of one or more clients will be materially limited by the lawyer’s responsibilities to another client, a former client or a third person or by a personal interest of the lawyer.
Id. Rule 1.7(b), however, will permit an attorney to undertake a representation that presents a concurrent conflict if certain conditions are met. Specifically, Rule 1.7(b) provides as follows:
(b) Notwithstanding the existence of a concurrent conflict of interest under paragraph (a), a lawyer may represent a client if:
- the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client;
- the representation is not prohibited by law;
- the representation does not involve the assertion of a claim by one client against another client represented by the lawyer in the same litigation or other proceeding before a tribunal; and
- each affected client gives informed consent, confirmed in writing.
Id. at Rule 1.7(b). This Rule provides attorneys with discretion to undertake representations that might actually present a concurrent conflict of interest as long as the conditions are satisfied.
These conflicts can generally be waived by the client, if such waiver is made under informed consent and in writing, but the attorney should pay special attention to the exceptions to waiver under subsections (1) and (3) above. Even if the attorney might otherwise be able to waive the conflict, the attorney should decline representation due to a conflict of interest if he or she believes that he or she cannot provide competent legal representation given the conflict, or the representation involves the assertion of a claim by one client against another. Id.
b. AICPA Code of Professional Conduct, Conflicts of Interest
The AICPA conflicts of interest rules are set forth in the AICPA Code of Professional Conduct § 1.100 and § 1.110. The AICPA standard for Conflicts of Interest somewhat mirrors that of the Model Rules. For example, if a CPA believes that the representation can be undertaken with objectivity despite a conflict of interest, and the CPA discloses the conflict to the client and the client gives consent, then the CPA can continue with the representation. See AICPA Code of Professional Conduct § 1.110.010.12. But the AICPA Code does not allow a CPA to waive a conflict of interest in a representation that requires independence under the Rules, such as in an audit or attestation engagement. See id.§ 1.110.010.03.
The AICPA Code, unlike the Model Rules, provides a specific framework for evaluating conflicts of interest The AICPA Code identifies not only specific scenarios where a conflict of interest might exist, but it also requires the use of a “formula” to evaluate the severity of a conflict of interest as follows:
When an actual conflict of interest has been identified, the member should evaluate the significance of the threat created by the conflict of interest to determine if the threat is at an acceptable level. Members should consider both qualitative and quantitative factors when evaluating the significance of the threat, including the extent to which existing safeguards already reduce the threat to an acceptable level. In evaluating the significance of an identified threat, members should consider both of the following:
- The significance of relevant interests or relationships.
- The significance of the threats created by performing the professional service or services. In general, the more direct the connection between the professional service and the matter on which the parties’ interests are in conflict, the more significant the threat to compliance with the rule will be. If the member concludes that the threat is not at an acceptable level, the member should apply safeguards to eliminate the threat or reduce it to an acceptable level
. . .
In cases where an identified threat may be so significant that no safeguards will eliminate the threat or reduce it to an acceptable level, or the member is unable to implement effective safeguards, the member should (a) decline to perform or discontinue the professional services that would result in the conflict of interest; or (b) terminate the relevant relationships or dispose of the relevant interests to eliminate the threat or reduce it to an acceptable level.
See id. § 1.110.010. The AICPA code goes into further detail and describes the different types of threats that may be present in a representation, and also lists what safeguards might mitigate such threats to an acceptable level. In essence, the AICPA Code makes a concerted effort to clarify exactly when conflicts of interest might exist in a representation, while the Model Rules merely provide a general rule that can be broadly construed.
c. Circular 230, Conflicts of Interest
Circular 230 sets forth the ethical standards required by a tax professional to practice before the IRS. Section 10.29 of Circular 230 forbids tax practitioners from having conflicts of interest. Specifically, it provides:
- Except as provided by paragraph (b) of this section, a practitioner shall not represent a client before the Internal Revenue Service if the representation involves a conflict of interest. A conflict of interest exists if—
- The representation of one client will be directly adverse to another client; or
- There is a significant risk that the representation of one or more clients will be materially limited by the practitioner’s responsibilities to another client, a former client or a third person, or by a personal interest of the practitioner.
Circular 230 § 10.29. But Circular 230 also provides for waiver of conflicts of interest if (1) the tax practitioner reasonably believes that he or she can still competently and diligently represent each client, (2) the representation is not prohibited by law, and (3) each client gives informed consent confirmed in writing at the time the conflict is known by the practitioner, but no later than thirty days. Id. Of important note, violations of Circular 230 may subject the practitioner to sanctions by the IRS Office of Professional Responsibility, and Circular 230 may be used to prove malpractice in a civil lawsuit against the tax professional. Id. § 10.50.
d. Differences Between Circular 230 and Other Rules
While the Model Rules, AICPA Code, and Circular 230 bear similarities to one another, Circular 230 contains specific rules for tax practitioners that depart sharply from the AICPA Code and Model Rules. Compared to the Model Rules, Circular 230 imposes three additional requirements on an attorney practicing before the IRS.
Circular 230 requires a practitioner to confirm a waiver of a conflict in writing within a reasonable period, but no later than thirty days after the conflict is discovered. Id.§ 10.29. The Model Rules and AICPA Code do not specifically limit the time to obtain a waiver of a conflict. Further, the Model Rules allow for an attorney to obtain informed consent verbally so long as it is later documented by the attorney, but Circular 230 requires that a document evidencing waiver of consent must be signed by the client. Cf. Model Rule 1.7; Circular 230 § 10.29. Lastly, Circular 230 requires that practitioners retain copies of the written consents for at least thirty-six months after the conclusion of the representation. Circular 230 § 10.29(c). The AICPA Code and Model Rules do not require practitioners to retain any written consents for such specific period of time. Adding to the confusion, the AICPA Code requires CPA’s to abide by the Circular 230 standards for written consent under Interpretation 1.110.010.18, but the Model Rules for attorneys in practice contain no such provision.
Prior to 2002, Circular 230’s conflict of interest provision was a simple prohibition against conflicts of interest absent express informed consent of each client—closely resembling Model Rule 1.7. The AICPA staunchly opposed the changes to Circular 230 that were proposed in 2007 that ultimately became § 10.29. See AICPA, Comments on Proposed Regulations, REG-122380-02 Regarding Regulations Governing Practice before the Internal Revenue Service, p.4. The AICPA raised serious concerns over the strict standards that the proposed § 10.29 presented to tax professionals. Namely, it expressed concerns over why such strict rules governing conflicts of interest were needed:
Section 10.29 of the proposed regulations would tighten the existing conflicts of interest provision by requiring that clients both waive and give informed consent to conflicts and that such waivers and consents be confirmed in writing by the affected client at the time the practitioner knows of a conflict. Previously, there was no waiver requirement, as long as there was informed consent, and a client’s informed consent could be confirmed in writing by the practitioner
. . .
The net result is one of the strictest (if not the strictest) conflict of interest regimes in the professional standards area.
. . .
It is not clear why the prior, more principle-based approach, needed to be supplanted by a more stringent, rule-based approach. For example, it is difficult to discern why both a waiver and informed consent should be required, or why the consent or waiver always must be confirmed in writing by the client. There is no indication of abuse that had not been, or could not be, adequately addressed by the former provision (which was recently overhauled in July 2002 to mirror American Bar Association (ABA) Model Rule 1.7). The lack of flexibility in the proposed approach is unnerving given the lack of clarity as to whether a conflict exists in many situations, as well as the blanket requirement that consents simply be provided to the IRS upon request.
Id. To add to the confusion, the stricter rules of Circular 230 only apply when the professional is acting as a “practitioner” within the rules of Circular 230. See Circular 230 § 10.2; § 10.29. Thus, determining which framework applies in a scenario can be a complex inquiry that can have serious consequences—especially when a professional is subject to both the AICPA Rules and Model Rules. As shown herein, a tax attorney must closely analyze the conflict of interest in conjunction with each applicable framework and apply the rule that is most strict to ensure proper compliance and avoid lawsuits or sanctions. An analysis of a specific conflict of interest scenario that all tax practitioners should be familiar with follows below.
e. Multi-Party Representation, Conflict of Interest Issue
An example where the conflict of interest rules discussed above apply is in multi-party representation. Not only do such situations commonly present inherent conflicts of interest, but rules regarding client confidentiality also typically apply. Model Rule 1.6 generally prohibits an attorney from disclosing client information to third-parties. AICPA Code § 1.700.001 prohibits a CPA from disclosing confidential client information without the client’s consent. But Circular 230 does not contain any specific provision regarding confidentiality of client information.
In a multi-party representation, a client may divulge information in confidence to the tax professional that creates a conflict of interest. A common example is a trust fund recovery penalty investigation arising in the context of a partnership. The partners’ interests in such a situation may ultimately be directly adverse to one another regarding who should ultimately be considered the “responsible persons.”
The tax professional owes a duty of confidentiality to his or her clients. But information provided by one client—information that if disclosed might breach such duty of confidentiality—might reasonably prohibit the professional from competently representing the other clients. For example, the disclosure by one partner that he or she willingly failed to deposit employment taxes might absolve the other partners of liability, but disclosure of this fact could breach confidentiality, especially if the partner requested that such information not be shared with the other partners. This situation presents a clear conflict of interest that potentially involves all three professional ethics frameworks. It is important that tax professionals understand the requirements of each framework to determine whether a conflict exists, if it can be waived, and how it must be waived under each framework. Although, conflicts of interest are just a small portion of ethical issues that may arise in a tax practice. Another common issue is analyzing contingent fee representations under the ethical frameworks.
II. CONTINGENT FEE TAX REPRESENTATIONS
Fees that are paid to the practitioner also present specific ethical issues—namely in contingent fee representations. Charging contingent fees in tax practice representations requires analysis of the Model Rules, AICPA Code, and Circular 230 because each framework applies different standards regarding contingent fee representations. For instance, Circular 230 § 10.27 prohibits “unconscionable fees” charged for matters before the IRS. Although, a definition of “unconscionable fee” is not provided anywhere in Circular 230, the existence of a contingent fee may be a factor bearing on whether a fee is “unconscionable.”
The Model Rules provide a set of factors to determine if a fee is unconscionable. Model Rule 1.5 states the factors to be considered are:
- the time and labor required, the novelty and difficulty of the questions involved, and the skill requisite to perform the legal service properly;
- the likelihood, if apparent to the client, that the acceptance of the particular employment will preclude other employment by the lawyer;
- the fee customarily charged in the locality for similar legal services;
- the amount involved and the results obtained;
- the time limitations imposed by the client or by the circumstances;
- the nature and length of the professional relationship with the client;
- the experience, reputation, and ability of the lawyer or lawyers performing the services; and
- whether the fee is fixed or contingent.
But these factors only determine if a fee was likely to be unconscionable under Circular 230—contingent fees being only a single factor to be considered. It is important to note that the AICPA contains its own rules regarding the prohibition of contingent fee arrangements.
In tax practice, the AICPA Code prohibits contingent fees for the “prepar[ation of] an original or amended tax return or claim for a tax refund for a contingent fee for any client.” AICPA Code § 1.500.001.01(b). This standard may be the strictest regulation of contingent fee arrangements.
Contingent fees are otherwise prohibited by Circular 230, with only four specific exceptions. Circular 230 § 10.27(b). Tax practitioners, in matters before the IRS, may only charge contingent fees in the following scenarios:
- A practitioner may charge a contingent fee for services rendered in connection with the Service’s examination of, or challenge to—(i) an original tax return; or (ii) an amended return or claim for refund or credit where the amended return or claim for refund or credit was filed within 120 days of the taxpayer receiving a written notice of the examination of, or a written challenge to the original tax return.
- A practitioner may charge a contingent fee for services rendered in connection with a claim for credit or refund filed solely in connection with the determination of statutory interest or penalties assessed by the Internal Revenue Service.
- A practitioner may charge a contingent fee for services rendered in connection with any judicial proceeding arising under the Internal Revenue Code.
Id. Further, IRS Notice 2008-43 allows practitioners to collect contingent fees for services rendered “in connection with a claim under section 7623 of the Internal Revenue Code.” IRS Notice 2008-43. This Notice was meant to serve as interim guidance in 2008 until § 10.27 could be amended, but the IRS has yet to amend this section of Circular 230 to reflect the interim guidance.
Practitioners must take special note of such contingent fee rules, but should also be aware that recent cases have called into question whether the Department of Treasury can actually regulate such contingent fee agreements or certain types of professionals. See Loving v. IRS, 742 F.3d 1013 (D.C. Cir. 2014); Ridgely v. Lew, 55 F. Supp. 3d 89, 90 (D.D.C. 2014). For example, in Loving, the court held that the IRS did not have Congressional authority, under Section 330, to regulate tax-return preparers. Loving v. IRS, 742 F.3d 1013, 1015 (D.C. Cir. 2014) (“The IRS may not unilaterally expand its authority through such an expansive, atextual, and ahistorical reading of Section 330. As the Supreme Court has directed in words that are right on point here, the “fox-in-the-henhouse syndrome is to be avoided . . . by taking seriously, and applying rigorously, in all cases, statutory limits on agencies’ authority.” (citing City of Arlington v. FCC, 569 U.S. 290, 133 S. Ct. 1863, 1874, 185 L. Ed. 2d 941 (2013))). Further, Ridgely specifically held that the IRS could not regulate contingent fee agreements regarding the preparation and filing of ordinary refund claims. Ridgely v. Lew, 55 F. Supp. 3d 89, 98 (D.D.C. 2014) (“But as Loving held, the IRS’s regulatory authority is expressly circumscribed by Section 330 . . . But the IRS never explained how Section 330(d), which concerns ‘the rendering of written advice,’ encompasses preparing or filing refund claims prior to formal legal representation. 31 U.S.C. § 330(d). If ‘written advice’ included such acts, it would also include preparing and filing tax returns, a possibility foreclosed by Loving. In any event, as the Court has explained, the plain text, context, and history of Section 330 paint a clear picture of the scope of the IRS’s authority with respect to the preparation and filing of Ordinary Refund Claims.”).
In light of such limitations on the Service’s authority under Section 330, some believe that the Service has implicitly accepted this limitation on its authority by declining to issue any further clarifying guidance. If such authority is indeed improper, then attorneys would be subject only to the unconscionable fee standard presented by Model Rule 1.5, and a CPA might only be subject to AICPA Code § 1.500.001.01(b). This would invariably give practitioners, especially attorneys, more freedom in negotiating contingent fee arrangements. But the Supreme Court and many other Circuits have yet to rule on this topic. Thus, the question of the scope of the Service’s authority to regulate contingent fee representations still remains unanswered.
III. ETHICAL ISSUES INVOLVING AMENDED RETURNS
Circular 230 § 10.21 governs a practitioner’s actions regarding errors on returns and filing amended returns. This section provides as follows:
A practitioner who, having been retained by a client with respect to a matter administered by the Internal Revenue Service, knows that the client has not complied with the revenue laws of the United States or has made an error in or omission from any return, document, affidavit, or other paper which the client submitted or executed under the revenue laws of the United States, must advise the client promptly of the fact of such noncompliance, error, or omission. The practitioner must advise the client of the consequences as provided under the Code and regulations of such noncompliance, error, or omission.
Circular 230 § 10.21. This section sets forth the actions that the practitioner must take in disclosing to the client non-compliance, errors, or omissions.
But the practitioner need not advise the client that filing an amended return is necessary. In fact, the practitioner should note that tax law does not require the filing of an amended return to correct an error. Badaracco v. Commissioner, 464 U.S. 386, 393 (1984) (stating that tax law does not require filing of an amended return). Under Circular 230, the practitioner must explain the consequences of failing to correct the error or omission, such as the exposure to penalties, criminal action, its effect on future filing obligations, possibility of an audit, or effect on duties to third parties such as stockholders or partners.
When the error is the fault of the practitioner, there is a potential conflict of interest regarding the filing of amended returns. Clearly, the practitioner’s interest in correcting the return may conflict with the taxpayer’s interest in not filing an amended return. In line with the conflict of interest rules described above, the practitioner should disclose the conflict to the client and obtain informed consent in writing, if not advise that the client seek advice elsewhere regarding correcting the return.
In no circumstance can the practitioner “force” the taxpayer to correct the error or omission. But the practitioner should always consider whether continuing the representation, given the client’s decision to keep the error or omission, is proper. This is a determination that should be made on a case-by-case basis.
The practitioner should use common sense and strive to make the most ethical decision in every scenario that might be presented in tax practice. But the difficulty lies within the details, namely the overlap, or lack of continuity, between the different regulatory frameworks that might apply to the practitioner’s conduct. One should take utmost care to analyze first what regulatory standard applies to the practitioner’s conduct before making a decision. The practitioner should then determine what conduct is required or prohibited by the regulatory standard and what conduct is merely advised or recommended. Only then can a practitioner make an informed decision that is ethical, lawful, and ultimately in the best interests of the public and his or her client.
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A line of cases in the D.C. Circuit Court has called into question the ability of the IRS to regulate the conduct of attorneys not directly engaged in proceedings before the IRS. See generally Loving v. I.R.S., 742 F.3d 1013 (D.C. Cir. 2014); Ridgely v. Lew, 55 F. Supp. 3d 89, 91 (D.D.C. 2014).
The question of if a professional is acting as “practitioner” within the definition of Circular 230 is another hotly debated topic. Critics have questioned the authority of the IRS to regulate certain professionals that might fall within the purview of Circular 230’s “practitioners” definition.
These cases look at the statutory authority of the Department of Treasury to create such regulations on professional conduct.
AICPA Statements on Standards for Tax Services No. 6 provides a good list of possible consequences of failing to correct an error or omission. See also Circular 230 § 10.21.
Make special note to comply with the specific guidelines of Circular 230 § 10.29.
The Model Rules are especially clear on this, as shown in Rules 1.6 and 1.7.