Circular 230 Case Processing and the Application of Monetary Penalties 

    PROCEDURE & ADMINISTRATION 
    by Nicholas Preusch, J.D., MSA, LL.M. candidate 
    Published June 01, 2014


    EXECUTIVE
    SUMMARY


    Illustration by SoberP/iStock/Thinkstock
    • Illustration by SoberP/iStock/ThinkstockThe IRS Office of Professional Responsibility (OPR) investigates reports of possible violations of Circular 230. Circular 230 covers many areas, including due diligence in return preparation, solicitation of clients, and the maintenance of firm procedures to ensure compliance with Circular 230 by all members of a firm.
    • Even if a person's actions violate Circular 230, OPR can levy sanctions against the person only if he or she falls under OPR's jurisdiction. OPR may take the position that Circular 230 applies even to unenrolled preparers.
    • Regardless of the nature of the potential violation that gives rise to an investigation, OPR will also check to make sure the firm and practitioners being investigated are current in filing and paying their own taxes, which may lead to additional sanctions.
    • OPR may impose a reprimand, censure, suspension, a deferred disciplinary agreement, disbarment, and/or monetary sanctions. Monetary penalties are potentially equal to all gross receipts derived from the sanctioned conduct.

    One of the biggest issues practitioners have with the IRS Office of Professional Responsibility (OPR) is a lack of information on what constitutes a violation of Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), and how OPR applies sanctions for such violations. Case law does not provide much guidance on practitioner conduct, as most cases concern tax practitioners who failed to file or pay their taxes on time.

    The following is intended to help clarify this subject by using examples from OPR issues and cases. While the facts are hypothetical, the analysis is drawn from actual cases.

    Example 1: A medium-size tax firm with only CPAs and employees taking the CPA exam generates approximately $800,000 a year in gross receipts from tax preparation and has net income of about $10,000 a year. For the past 10 years, this firm's sole method of advertising has been hiring a local firm that runs the same local television ad each year. The advertisement states, "Our licensed attorneys and CPAs will guarantee the largest refund you can get." The ad is also posted on YouTube. However, the firm does not, in fact, employ any attorneys. The firm's owner reviews and approves the advertisement.

    During the regular course of business at OPR, an OPR attorney finds the ad on YouTube. Solely because of the ad, the attorney decides to open a case on the firm. Depending on the outcome of the case, the firm, its owner, and tax managers could be liable for as much as $4 million in monetary sanctions.

    This article is intended to walk practitioners through determining whether the hypothetical in Example 1 warrants sanctions under Circular 230, and, if so, why and to whom the sanctions apply.

    Receiving the Case

    OPR can either self-generate referrals or receive them from other branches of the IRS or from outside the IRS.1 In Example 1, the case originated with an OPR attorney viewing YouTube. OPR has also used sources such as the Better Business Bureau, Ripoff Report, and company webpages to generate potential cases. A case such as this could also be brought to OPR's attention from a disgruntled employee of the firm or by a taxpayer who feels cheated by the firm. No matter the source, OPR will investigate each referral made to its office.

    OPR's First Determinations and Section 10.20 Letter

    In Example 1, after OPR has found the ad and deemed it may be false or misleading, OPR will then send a Section 10.20 letter. Under this section of Circular 230, OPR has the right to request information from any person or firm that falls under its jurisdiction.2 Failure to provide any information requested under this section is a violation and is subject to discipline under Circular 230.3

    In a typical Section 10.20 letter sent to a firm, OPR will always ask two questions. The first relates to jurisdiction, and the second is related to Circular 230, Section 10.36(b). It will also ask questions relating to the specific misconduct OPR is investigating.

    OPR will first ask for an organizational chart to determine who has responsibility in the firm and over whom in the firm OPR has jurisdiction. Second, OPR will ask for a copy of the firm's procedures to ensure compliance with Circular 230. Section 10.36(b) of Circular 230 requires any practitioner with principal authority of overseeing a firm's tax practice to take reasonable steps to ensure the firm complies with Circular 230. In Example 1, OPR would probably also ask who is responsible for the advertisements, who created them, and what percentage of the firm's clients were retained based on them.

    Following Up With OPR

    If the firm does not respond to OPR's requests in the Section 10.20 letter, it or its principal members could be reprimanded, censured, suspended, or disbarred, depending on the egregiousness of its refusal to respond.Assuming the firm responds, OPR will then analyze the information the firm provided. Assume the firm in Example 1 provides the following information:

    1. The firm has three levels of employees. It is headed by a CPA, and under the head of the firm are four CPAs in managerial roles. Everyone below manager is an entry-level employee currently taking the CPA exam.
    2. The firm mails a tax organizer to its clients each tax season. The tax returns are then prepared from the information provided by the clients. The firm does not check the information for accuracy but only relies on the clients' information. The firm then reviews the tax returns at three levels for any typos or other errors before final approval.
    3. An outside advertising firm puts together the ads each year. In a recent customer survey, 80% of the clients said they came to the firm because of the ad, and the other 20% of the clients came because of word of mouth.
    Violations of Circular 230

    Based on these facts, OPR will look at violations of Circular 230, Sections 10.22, 10.30(d), and 10.36(b). To fully grasp these violations and whether OPR will pursue them, it is best to look at each violation independently to determine why there is a violation and to whom it relates.

    Circular 230, Section 10.22

    Under Circular 230, Section 10.22, practitioners must exercise due diligence when preparing tax returns. Practitioners can rely on another person or firm if the practitioner uses reasonable care in evaluating the person or firm, while considering the nature of the relationship between the other person or firm and the practitioner.4 A practitioner can use this reasonable-care standard as an affirmative defense if OPR alleges a violation of failure to exercise due diligence. OPR will not raise this defense for the practitioner.

    A practitioner must analyze all the facts and circumstances to determine whether he or she has violated Circular 230. In the facts discovered in the OPR follow-up, the firm in Example 1 receives information from clients and prepares tax returns based on that information. It is not the firm's policy to follow up on any questionable matters in the questionnaire. Even in the review process, the firm is only looking for typos or blatant errors.

    By not following up on client information that could be inaccurate, the firm is not exercising due diligence when preparing returns. One example of this occurred in the Kaskey case,5 in which the tax return preparer prepared a Form 1120, U.S. Corporation Income Tax Return, and a Form 1040, U.S. Individual Income Tax Return, for a taxpayer. The practitioner entered a deduction for wages paid to the taxpayer on the Form 1120 but then included a lesser amount of wages received by the taxpayer on his Form 1040. Here, the practitioner should have known something was wrong with the numbers he received from the taxpayer, and he should have questioned the information provided. Since he did not use due diligence, the practitioner was disbarred from practice.6

    Once a violation of Circular 230 has been established, OPR next determines who at the firm is liable for it. In Example 1, any person preparing the return would have failed to exercise due diligence. The tax managers who reviewed the tax returns may use the reasonable-care affirmative defense by showing that the return preparers were properly trained and supervised.

    Absent any evidence that the preparers were properly trained and supervised, the violations of Circular 230 will most likely extend to both the preparers and the tax managers. Assuming the tax managers have high-quality experience, the firm owner should be able to show that they were properly trained and supervised.

    The preparers and tax managers each have violated Circular 230, Section 10.22.7

    Section 10.30(d)

    Circular 230, Section 10.30(a), forbids practitioners from using or participating in the use of any public communication or private solicitation containing a false, fraudulent, misleading, or deceptive statement or claim. Section 10.30(d) further states that a practitioner cannot receive assistance from any person or entity that the practitioner knows obtains clients in such a manner or otherwise uses such statements or claims.

    That the ads in Example 1 are on YouTube and aired on local television suggests the tax managers and preparers know, or should know, of them. Therefore, if the ads are misleading, each person in the organization may have violated Circular 230.

    First, the ad says the firm employs licensed attorneys; however, the firm has never hired an attorney. This is misleading to potential clients, who may be expecting an attorney to perform the work for which they hire the firm. Firms cannot offer the help of a licensed professional whom they cannot use. In prior cases,this offer of help from a licensed professional included a firm without attorneys or CPAs using keywords such as "tax attorney" and "CPA" in the metadata of its website to receive more hits on Google.

    Second, the ad contains a guarantee. While a guarantee itself might not be misleading, it could be considered a prohibited contingent fee.8 Here, however, the guarantee is misleading, as it offers "the largest refund you can get." This type of language tends to persuade people who "refund shop." In an ideal world, the largest refund a taxpayer can receive would be the same no matter which preparer the client goes to. Therefore, this guarantee may be seen as misleading potential clients.

    Since everyone in the firm knew of the advertisements and benefited from them, the firm owner violated Circular 230, Section 10.30(d), and the preparers and tax managers violated Sections 10.22 and 10.30(d).9

    Section 10.36(b) and Compliance Audits

    Under Circular 230, Section 10.36(b), a firm and people with authority over a tax practice "must take reasonable steps to ensure that the firm has adequate procedures in effect for all members, associates, and employees for the purposes of complying with Circular 230."

    OPR's follow-up with the firm in Example 1 shows that the firm's only safeguard to ensure compliance with Circular 230 is to conduct multitiered reviews of returns. However, this function falls far short of helping to comply with Circular 230.

    First, the firm should require ethics education each year.Second, while a multitiered review is appropriate, in this example it failed to address the preparers' due-diligence issues. A better structure to avoid liability under Circular 230 would include written policies to question large, unusual, or questionable items on the organizer and to document and retain in records the answers.

    In addition to the other policies, the firm should also have safeguards on its billing procedures to ensure it does not use contingent fees. The firm should also have a policy of when and how to return documents to clients.

    Circular 230, Section 10.36(b), provides that practitioners who have or share principal authority and responsibility for a firm's tax practice must take reasonable steps to ensure firm members, associates, and employees comply with Circular 230. Had the firm owner and tax managers taken reasonable steps for the firm to comply with Circular 230, then they could make that an affirmative defense against the sanction. Some firms comply with this section by undergoing a compliance audit of their Circular 230 procedures. These audits review the firm's internal procedures and document where the firm is strong and where it needs to improve in regard to Circular 230. By supplying this type of audit compliance letter to OPR and showing they have taken steps to improve their weaknesses, firms may avoid monetary sanctions.

    Jurisdiction

    Although everyone in the firm in Example 1 has committed one or more violations of Circular 230, can OPR do anything about it? For OPR to enforce any sanction, the person who committed a violation of Circular 230 must fall under OPR's jurisdiction.

    Attorneys, CPAs, or enrolled agents are subject to Circular 230.10 In Example 1, the firm owner and tax managers are CPAs involved in reviewing tax returns. Thus, they fall under the scope of Circular 230 and can be sanctioned.

    While the recent decision in Loving11 struck down the IRS's return preparer registration initiative requirements, this does not necessarily mean that non-CPA preparers in the firm in Example 1 will not be subject to sanctions for violating Circular 230. OPR may take the position that Circular 230, Section 10.8(c),12 which extends Circular 230 to any individual who prepares any portion of a document pertaining to any taxpayer's tax liability for submission to the IRS, gives it jurisdiction over non-CPA preparers. However, this jurisdictional premise has yet to be tested in court. In addition, non-CPA preparers should remember that as paid tax return preparers, they are still subject to the provisions of Sec. 6694 regarding understatements of tax liability by a return preparer.

    Example 2: A person who is not an attorney, CPA, or enrolled agent runs a tax debt resolution company with two branches. One branch is an advertising center that handles all client intake calls from all the firm's television advertisements and direct mailings. The other branch handles all tax debt resolution work. The tax debt resolution company is using its advertising branch to make outrageous claims such as settling tax debts for pennies on the dollar to entice clients to sign with the firm.

    The people on the advertising side do not fall under Circular 230 jurisdiction, as they are not attorneys, CPAs, or enrolled agents, and they are not preparing any tax documents. They are simply handling the phone calls for the firm's client intake.

    In addition, if the owner simply runs the firm's day-to-day operations, then he, too, would not be subject to Circular 230 jurisdiction if he is not an attorney, CPA, or enrolled agent. In fact, the only way for OPR to bring an allegation for false or misleading advertisements against such a firm would be if someone in the tax debt resolution branch knew of the advertising scheme. Then OPR could bring an allegation against a person in that branch, which would then allow OPR to pursue monetary sanctions against the firm under Circular 230.

    Additional Violations of Circular 230

    Now that there are violations against each person in the firm in Example 1 and OPR has established jurisdiction over the firm, the next step for OPR is to check the tax compliance of the firm and each person who has violated Circular 230. If the firm or any of the practitioners are late in filing their personal tax returns or have a large balance due on their account, they may face additional sanctions under Circular 230, Section 10.51(a)(6), which states it is a violation of Circular 230 to willfully fail to file a federal tax return or to willfully evade the payment or assessment of taxes due. This includes all types of federal taxes, including tax returns for flowthrough companies, even if no tax is due, and for employment taxes.13

    Statute of Limitation

    The statute of limitation for OPR cases is five years.14 In Hernandez, the administrative law judge and appellate authority confirmed a five-year statute of limitation from the date a return was due.15 However, OPR takes the view that this statute of limitation applies only to tax compliance cases. The statute of limitation for conduct cases has never been tested in court, and, therefore, from an agency perspective, no statute of limitation currently exists for the conduct of tax practitioners.

    In Example 1, then, everyone in the firm subject to Circular 230 could be open to sanction for any conduct ever committed. Practically, however, OPR would not likely challenge the five-year statute of limitation for tax conduct and would limit the sanctions to actions in the past five years.

    Sanctions

    OPR can use several types of sanctions against practitioners and firms, including reprimands, censures, deferred disciplinary agreements, suspensions, disbarments, and monetary sanctions.16

    A reprimand is a private letter to a tax practitioner discussing his or her inappropriate conduct. The reprimand is not shared with any inside or outside parties. It remains part of the practitioner's file in case of future Circular 230 malfeasance.

    A censure is a public reprimand that discloses in the Internal Revenue Bulletin the practitioner's name, location, and section of Circular 230 the practitioner violated.

    In a deferred disciplinary agreement, the practitioner promises OPR that he or she will remain compliant with Circular 230 for a set time. If the practitioner remains compliant, the case is closed. If the practitioner again violates Circular 230 within the time provided under the agreement, he or she will be suspended automatically. These agreements are more common in tax compliance cases to allow practitioners a chance to become and remain compliant.

    Suspensions stop practitioners from practicing before the IRS for the suspension period. After the suspension period, the practitioner's practice before the IRS may be subject to conditions. Typically, in tax compliance cases, for each year practitioners fail to file a tax return, they can expect a one-year suspension, absent mitigating factors. However, a practitioner with five or more years of unfiled tax returns is almost always automatically disbarred.17 For practitioner misconduct, suspensions are not as readily determinable.

    If a practitioner is disbarred, he or she will not be allowed to practice before the IRS unless and until authorized by the IRS. Disbarred practitioners may petition for reinstatement after five years.18

    OPR's policy is to not allow practitioners to buy their way out of trouble by satisfying a monetary sanction to avoid one of the nonmonetary sanctions.19 Practitioners who violate Circular 230 should expect one of the previously mentioned sanctions to apply, rather than a monetary sanction, which is applied where OPR cannot correct conduct with one of the nonmonetary sanctions.

    In Example 2, if OPR suspends a tax practitioner employed by the firm for knowing of the false advertising, the firm will most likely simply fire the practitioner, hire a new one, and continue to operate as it always had. One would hope that with the IRS suspending enough practitioners, people would get the hint not to work there. However, taxpayers are being hurt until that happens or the firm changes. This means the tax debt resolution firm's actions perhaps could be changed only by a monetary sanction.

    Monetary sanctions can be imposed up to an amount equal to the gross receipts derived from the sanctioned conduct.20 In Example 2, the conduct occurred during client intake. Therefore, all of the firm's gross receipts could be included in calculating the amount of a monetary sanction, since client intake involves 100% of its clients.

    Sanctions Applying to Example 1

    In Example 1, sanctions likely apply against the preparers (if they are subject to Circular 230), the tax managers, and the firm owner.

    The preparers have violated Sections 10.22 (due diligence) and 10.30 (solicitation). Due diligence is the biggest concern for the preparers, as they did not have much say in the firm's advertising or its procedures. As such, the preparers would probably be censured, as theirs is easily correctable conduct that may not have affected the tax system much, unless OPR has prior similar behavior on file.

    The tax managers have violated Sections 10.22, 10.30, and 10.36(b). The worst violation is of Section 10.36(b), as it really encompasses the other two violations, and had the firm used proper procedures, the other violations most likely would not have occurred. Here, the most likely sanction for the managers would be a suspension. A suspension makes sense because the inaction of the managers and the inadequate procedures allowed multiple violations of Circular 230 to occur. A monetary sanction, coupled with the suspension, would be another way to persuade proper conduct in the future from these tax managers.21

    The firm owner also violated Sections 10.22, 10.30, and 10.36(b). The same analysis would hold true for the firm owner, except the violation for false advertising would most likely increase any suspension that the owner would receive, compared with the tax managers.

    The firm can also be held liable for a monetary sanction since it did not have the proper procedures in place to stop the violations. Determining the monetary sanction in this case would be simple. First, there is the violation for advertising. The firm disclosed that 80% of its clients were from its advertising campaigns. If OPR only included clients gained through the advertising campaigns, it would multiply the gross receipts from the past five years by 80%. However, OPR may assert that the firm's entire gross receipts are subject to sanction.

    The firm had gross receipts of $800,000 in each of the past five years. If OPR asserts the entire amount of the firm's gross receipts are subject to sanction, the monetary sanction against any of the people found to have violated Circular 230 and the firm could be $4 million. Nothing in Circular 230 stops OPR from imposing the monetary sanction against the tax managers, the firm owners, and the firm. Theoretically, there could be $24 million in penalties, since five people and one entity could each be subject to a $4 million sanction.

    Actions for Firms

    Firms and practitioners not already doing so must start taking steps to protect themselves against sanctions from OPR. The best way to do this is to enlist a consultant to review firm operations. Even without a consultant, firms should start keeping separate documentation of their Circular 230 procedures in case they receive a Section 10.20 letter from OPR. Only through proper procedures and thorough documentation can a firm escape potentially harsh penalties.

    Footnotes

    1 Circular 230, §10.53.

    2 Circular 230, §10.20(a)(3).

    3 Id. There is an exception for privileged information, but the burden is on the practitioner to show the information is privileged.

    4 Circular 230, §10.22(b).

    5 OPR v. Kaskey, Complaint No. 2009-26 (Decision on Appeal 6/28/10).

    6 The decision also found that the preparer willfully failed to file his own individual tax return.

    7 The preparers, however, may not be subject to Circular 230. See "Jurisdiction" section in this article. 

    8 Circular 230, §10.27(c)(1).

    9 Again, the preparers may not be subject to Circular 230. See "Jurisdiction" section in the article above.

    10 Circular 230, §10.2(a)(5).

    11 Loving, 917 F. Supp. 2d 67 (D.D.C. 2013), aff'd, 742 F.3d 1013 (D.C. Cir. 2014). In the return preparer initiative, the IRS sought to set up a system of registration, testing, and continuing education for return preparers who are not attorneys, CPAs, or enrolled agents.

    12 Circular 230, §10.8(c), was included in the same final regulations (T.D. 9527) as the sections of Circular 230 that set out the return preparer registration requirements. However, as the district court stated, the plaintiffs in Loving were only challenging the return preparer registration requirements, not the regulations in T.D. 9527 as a whole. See Loving, 917 F. Supp. 2d 67 (D.D.C. 2013).

    13 OPR v. Pezzo, Complaint No. 2013-02 (Default Decision 9/16/13).

    14 28 U.S.C. §2462.

    15 OPR v. Hernandez, Complaint No. 2010-09 (Decision on Appeal 6/26/11).

    16 Circular 230, §§10.50 and 10.60(a).

    17 OPR v. Ashley, Complaint No. 2013-03 (10/9/13).

    18 Circular 230, §10.81.

    19 Notice 2007-39.

    20 31 U.S.C. §330(b); Circular 230, §10.50. The OPR at its discretion may impose a monetary sanction less than the full amount of the gross receipts.

    21 Although OPR has not imposed monetary sanctions against either firms or individual practitioners up to this time, it described the requirements for imposing monetary sanctions in Notice 2007-39 and plans to begin imposing monetary sanctions in the future.


    Contributor

    Nicholas Preusch is an attorney with E. Cohen and Co. CPAs in Rockville, Md., and is a former attorney with the IRS Office of Professional Responsibility. For more information about this article, contact Mr. Preusch at npreusch@gmail.com.



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