Where do we draw the line?

Once a client took the same spreadsheet of deductions from the previous year, changed the dates and submitted it to me again the next year for his business.

Another time a client told me that "eighty percent" of the gross income shown on their Form 1099-MISC was expenses, with ten percent here and twenty percent there, and expected me to compute the actual figures.

These kinds of things are obviously covered by the due diligence requirements of Circular 230. But what about smaller things? Where do we draw the line?

1) Suppose a client has believable figures for their noncash charitable contributions, but they get a bit "fuzzy" on the details. They seem to be making up dates and descriptions.

2) Suppose income and deductions totaling no more than a few hundred dollars need to be allocated between states for a split year return and the client asks if we can just estimate based on the number of months spent in each state.

In both cases, federal tax liability is unaffected. In the case of the state allocation, nothing on the federal return is affected at all. Are these scenarios on the safe side of the line?

AICPA's SSTS No. 4 permits the use of estimates "[u]nless prohibited by statute or by rule", and provides that "a member may prepare a tax return using a taxpayer’s estimates of the missing data".

Circular 230 doesn't say anything about estimates, and doesn't cover state returns either.

Circular 230 doesn't say anything about estimates, and doesn't cover state returns either.

Indirectly it covers states, in that EA status in some states confers treatment equivalent to attorneys or CPAs, and Circ. 230 governs what it takes to be an EA in good standing.

Because of several court rulings, Circ 230 really only matters if you want to represent taxpayers before the IRS. OPR/RPO cannot revoke your ability to prepare tax returns for pay, to the detriment of all true professionals. There are various penalties for preparers, but not a general one for neglecting due diligence (just the specific due diligence for EIC, AOTC, CTC, and so on).

I use the "good faith reliance on taxpayer" bit in Circ 230 §10.34(d) for most of the issues you identified. But I would not accept a spreadsheet that just applied percentage formulas to gross income.

As President Reagan famously said "Trust, but verify".

If your name is on the return, you are responsible for the return.

If your name is on the return, you are responsible for the return.

As preparers, we are not responsible for the items on the return...most specifically the tax liability. As has been noted above, we may rely upon information provided in good faith by a taxpayer. We need not audit this information to use it without consequence. However, we may not use information we know is false and must take reasonable steps to determine information is proper.

At the end of the day, the taxpayer signs the "perjury" line. If they've given us improper information, they will bear the consequence.

As professionals we know when something does not pass the "smell test". We are not auditors but if something does not look right it is incumbent upon us to inquire and make a note of the explanation in case questions come up later on.

For example i routinely inquire about Misc Expenses if it seems to be out of the norm given the type of business and previous history. 9 out of 10 times it is a business expense that could be categorized in another item. One year I had a taxpayer with over $5000 in misc. expense. Come to find out virtually all of it was for casual help paid in cash.

When I've had someone who appeared to be making things up, I'll inform them that I don't counsel in how to commit fraud. That usually surprises them because they don't think of it in those terms. If they still want to pursue whatever they have presented, I'll send them home with "homework" which is to go through their records and provide better information. I have a few people in town who either found someone to accept their bogus numbers, did the returns themselves with the bogus numbers, or who, after all this time (in some cases years), are still working on the numbers. I may accept a small guesstimate, but not the entire return.