Response: warning clients of the need to amend

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#1
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New clients as of 2019.

They lied to me about not renting a property in 2019.

They sold the property in 2020, I fished out the truth, and sure enough it was rented, along with a 2nd property.

I will finish the tax return this year and fire the client, but how do I tell them the need to amend their tax returns for all years in which they had rental property (and file the appropriate state returns)?

R-mail (registered email): (when the tax return is completed in a couple of days)

"Dear client,

Even though we clearly asked in writing last year and you replied that you did not rent property in 2019, it has become known to us this year that you have been operating as a landlord for one or more properties. This must be reported to the IRS and the appropriate states for each year for which you had rental activity. This will require amended tax returns and filings for each state, as appropriate. Failure to do so could result in tax and penalties from the IRS and the state, and this could be considered to be a willful understatement of tax. Filing these amendments and tax returns are beyond the scope of our engagement and we will not be available to provide these services. We recommend that you engage with a professional who can help you with these right away."

(then send generic disengagement)
 

#2
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How are you handling the depreciation recapture on the sale of the rental, that was never "depreciated"?

I would send the letter via certified mail, so you have proof?
Always a fan of the certified mailings. Maybe I'm just old school.
 

#3
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ReckedCPAEA wrote:How are you handling the depreciation recapture on the sale of the rental, that was never "depreciated"?

I would send the letter via certified mail, so you have proof?
Always a fan of the certified mailings. Maybe I'm just old school.



I'm including it by the amount they could/should have taken.

"Allowable".

"R-mail" provides proof of sending similar to certified snail mail.
 

#4
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For depreciation, you'd file a Form 3115 for an automatic change, and take all PY as a net negative 481(a) adjustment.

This would not, of course, remedy the PY unreported income issue, but at least you'd be reporting proper unrecaptured Sec. 1250 properly.
 

#5
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Since I have no experience with 3115 (tried it once, was not confident with the result), should I refer him elsewhere?
 

#6
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There is a resident accounting change method advisor here that can guide you through the process and you pass along the cost to the client.
Coddington is the name.
 

#7
sjrcpa  
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How was the property treated in 2018?
 

#8
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If a client lied to me, I'd be very tempted to fire the client in the middle of the engagement. We have proximity to a deadline, so I'd check with my E&O first.

If they lied to you about this pretty material thing, what else are they lying about that you haven't "fished out" yet?
 

#9
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sjrcpa wrote:How was the property treated in 2018?


Not reported. I asked for more records and depreciation records, haven't heard back.

ManVsTax wrote:If a client lied to me, I'd be very tempted to fire the client in the middle of the engagement. We have proximity to a deadline, so I'd check with my E&O first.

If they lied to you about this pretty material thing, what else are they lying about that you haven't "fished out" yet?


Yup.

I don't like the clients (because of this), but I usually like to finish and then disengage. But I don't have the bandwidth or experience to complete form 3111 for them. And I'm not sure how they will react to the fee for it if I outsource.

I feel like I'm more in "defense and CYA" mode at this point rather than "help the client" mode - if you know what I mean. But perhaps that is harsh. Many taxpayers think that if they have no net income that they don't have to report rental activity.


As of right now, I asked for more tax returns and the depreciation records and I haven't heard back.
 

#10
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How do you know they're not going to cause you to file another false or fraudulent return again this year??

I can understand wanting to be the nice guy, but you have to reflect on the professional risk of moving forward, as well as the ethical standards of your profession and your office.
 

#11
Taxaway  
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I agree with ManvsTax, how can you have any faith in the accuracy of the tax return you're preparing for them now? I would disengage based that they lied to you as your clients in 2019, if that were the case. Yes, in addition to ethical reasons but being p'od about the lying too!

I'm not sure how you could incur any liability in terminating close to the deadline....the supposition is that you'd have to prepare a possibly fraudulent return if other untruths remain? Advise them to file an extension, make a payment if needed, and seek assistance elsewhere?
 

#12
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ManVsTax wrote:How do you know they're not going to cause you to file another false or fraudulent return again this year??


A client would have to be pretty contrite and explain their misunderstanding of my question in the prior year before I would even entertain preparing another return after an omission of this nature. The CYA here is not completing the engagement, but advising them they need assistance (due to unforeseen circumstances of their creating) that is outside the scope of services you are willing to provide.
Send them a bill for work to date and send them away.
~Captcook
 

#13
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Dear clients,

On the 4th of January, 2020, you had provided a new client questionnaire marked "yes" when it asked if you had property that was held out for rent.

In an email dated the 8th of March, 2020, while working on your 2019 tax returns, I advised you that this activity was required to be reported on your tax return and provided a worksheet to fill out so we could report the activity.

Your reply on the 9th of March was, "property not ready for rent yet. Lot of repairs have gone into the property trying to get it up and ready for rent."

I had also asked "What date did you start renting out this property to others?" And your answer was "not yet."

On the rental worksheet you filled out for us last month, you indicated that this property was only held out for rent since the 30 of December, 2019.

Then a few days ago when I asked about the sale via email, you had answered from Jan 2012-Jan 2020.

When I asked you to clarify this discrepancy, Mrs. client answered that the property was rented from -Jan 2012-May 2014, Jun 2014-May 2015, Jul 2015-May 2019, and Dec 2019-Jan 2020.

As a result of being misled in 2020 when working on your 2019 tax returns and just now receiving this information in the last few days, I now believe that your 2019 federal tax return was not filed accurately and must be amended to include this activity. Your 2018 federal tax return (which I have seen but did not prepare) likely needs an amendment as well. Possibly, other previously filed tax returns might need amendments, though I haven't seen them.

It is also my opinion that you are required to file state income tax returns to report this activity.

Lastly, to correctly report the sale of your rental property in 2020, you will likely need form 3115 to correct the mistake of not reporting the sale and claiming depreciation.

We will unfortunately be unable to provide you with any professional services moving forward. The preparation and filing of these amendments and form 3115 is beyond the scope of my experience and is not a service for which I am willing or able to provide. This concludes our engagement to prepare and file your 2020 income tax returns.

As a result, it would be prudent for you to reach out to a tax professional as soon as possible to facilitate the filing of all of your personal and/or business income tax returns by the applicable deadlines. Failure to file the respective returns by the pertinent deadlines may result in the assessment of penalties and/or interest.

Here is a quick list of firms that may be able to help you. Please note that I am not personally familiar with these firms and you should do your own due diligence prior to hiring them.

Firm 1
Firm 2
Firm 3

Thank you and best wishes with completing your 2020 tax filings.
 

#14
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I tend to find it best for me if I'm concise and slightly vague as to reasons in a disengagement or firing email. YMMV.
 

#15
LW25  
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"Dear client,

Even though we clearly asked in writing last year and you replied that you did not rent property in 2019, it has become known to us this year that you have been operating as a landlord for one or more properties. This must be reported to the IRS and the appropriate states for each year for which you had rental activity. This will require amended tax returns and filings for each state, as appropriate. Failure to do so could result in tax and penalties from the IRS and the state, and this could be considered to be a willful understatement of tax. Filing these amendments and tax returns are beyond the scope of our engagement and we will not be available to provide these services. We recommend that you engage with a professional who can help you with these right away.


Addressing the U.S. Federal income tax issues (not the state issues):

Under the U.S. Internal Revenue Code, there is no general legal requirement to file an amended Federal income tax return.

The Internal Revenue Code does not require a taxpayer to file an amended return to correct a mistake discovered after the filing of the original tax return. The words ‘‘amended return’’ scarcely appear in the code.

[ . . . ]

In Broadhead v. Commissioner, the Tax Court held that Treasury regulations do not require a taxpayer to file an amended return, even after being advised to do so by an accountant.


---T. Keith Fogg and Calvin H. Johnson, from Amended Returns - Imposing a Duty to Correct Material Mistakes, 120 Tax Notes 979 (Sept. 8, 2008) (footnotes not reproduced).

I would go a step further and say that I know of no Code or Treasury regulation general requirement to file an amended return, even where the taxpayer knew the original return was materially false. This concept might seem to defy common sense -- but were are talking about law here, not common sense.

The following applies to AICPA members, and to CPAs licensed in states (such as Texas) where this rule has been incorporated by reference into the Rules of the applicable State Board:

A member [of the American Institute of Certified Public Accountants] should inform the taxpayer promptly upon becoming aware of an error in a previously filed return, an error in a return that is the subject of an administrative proceeding, or a taxpayer’s failure to file a required return. A member also should advise the taxpayer of the potential consequences of the error and recommend the corrective measures to be taken. Such advice and recommendation may be given orally. The member is not allowed to inform the taxing authority without the taxpayer’s permission, except when required by law.

[ . . . ]

Although recognizing that the taxpayer may not be required by statute to correct an error by filing an amended return, a member should consider whether a taxpayer’s decision not to file an amended return or otherwise correct an error may predict future behavior that might require termination of the relationship.


--from Statement on Standards for Tax Services No. 6, Knowledge of Error: Return Preparation and Administrative Proceedings, Tax Executive Committee, American Institute of Certified Public Accountants (effective Jan. 1, 2010) (emphasis added).

In the letter to the client, I would leave out the part about "willful understatement of tax." Instead, I would tell the client to consider consulting with a tax attorney.

As an aside: The willful understatement (if any) would relate to the filing of the original return -- not to the failure to file an amended return.
 

#16
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ManVsTax wrote:I tend to find it best for me if I'm concise and slightly vague as to reasons in a disengagement or firing email. YMMV.


Agree 100%. I might share some of the detail you outline orally with the client, if pressed, but probably not.
I would definitely document this in my file for future reference, but putting it in writing increases the likelihood of them disagreeing with your impression/analysis/conclusion of the circumstances. That isn't the goal here. The goal is to let them walk away and not spend any more time/effort on your part.

Dear Clients,

We recently clarified the circumstances related to your rental activity. This was new information to me and creates a filing situation outside the scope of my ability to serve you well. Enclosed is a bill for the work performed to date.

Please let me know if your new professional needs any information from me to allow for a smooth transition to their services. Thank you for your trust in me to handle your work to date.

Best wishes,
~Captcook
 

#17
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LW25 -- Circular 230 might have something to say about what one should do in OP's situation. I would consult Circ 230 and fulfill any obligations under that either immediately before firing and simultaneously.
 

#18
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Why am I billing here? I'd rather eat the work than have the client feel like I owe it to him to support the little I've done.

I thought circ 230 said I have to notify them that they should amend to include all income.
Last edited by ItDepends on 22-Apr-2021 10:47am, edited 1 time in total.
 

#19
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I'd probably do an extension for the client considering the due date?
But if tax ends up being owed, I imagine that will come back to bite you as well if you do a $0 extension.

This is a very tough position to be in.
 

#20
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ItDepends wrote:Why am I billing here? I'd rather eat the work than have the client feel like I owe it to him to support the little I've done.


You are certainly free to "eat" the work, but I would send a bill for the work if it were me. I don't work for free. I don't spend my time on client projects to have them change the scope and cause me harm. They get to pay for that privilege.
~Captcook
 

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