Should You Represent Your Client Undergoing an Audit?
Even if defending your clients in audits is your passion or an area you want to learn more about, it’s important to consider a number of factors before deciding if you should represent your client in an audit.
Questions to consider include whether you’re the right person to represent your client, if there is a built-in conflict of interest, if you have the time and resources to devote to resolving the audit, and if you are protected under attorney-client privilege.
It goes without saying that audits can be more than complex. Deciphering the various types of correspondence from the IRS, determining what type of audit it is, and the strategy with which to approach it can be daunting.
Add in the time and resources it takes to resolve an audit and a client who either doesn’t understand the severity of the correspondence or keeps you out of the loop, and you’ve got a full-blown problem on your desk − and it can easily happen during your busiest time of year.
In 2016, the IRS processed more than 244 million tax returns and engaged in millions of compliance activities. With most tax preparation firms handling between 300 and 500 returns annually, it’s likely that at least one of your clients has been audited in the past or might be audited in the future − especially considering the IRS can audit returns for three years after the year the return was filed and sometimes up to six years for substantial errors.
Representing Your Client
The first factor to consider is if you’re the right person to represent your client before the IRS or in US Tax Court. Representing your client in front of the IRS or in Tax Court requires two separate types of qualifications.
To represent your client before the IRS, you must be an attorney, a CPA, or an enrolled agent (EA). There are others who can represent taxpayers, but with many limitations − including enrolled actuaries, family members, and unenrolled return preparers who prepared the return and are part of the IRS Annual Filing Season Program for the year they prepared the return and the year of the audit/notice.
To represent your client in Tax Court, which has jurisdiction over a case that is at the Notice of Deficiency stage and beyond, you must be either an attorney or a US Tax Court Practitioner (USTCP). Although a taxpayer is allowed to prepare their own Tax Court petition, those who prepare and submit petitions on behalf of someone else must be an attorney or a USTCP. CPAs and EAs are not allowed to practice in the Tax Court unless they are on the Roll of Practitioners of the Court. Legally, you will not even be allowed to assist your client in filling out the Tax Court petition unless you have the required designations.
Conflict of Interest
While your overall role is to serve your client to the best of your abilities, as required in Circular 230, it’s important to keep your best interest in mind as well. Representing your client when you’ve prepared their tax return could lead to a conflict of interest, according to Circular 230 §10.29. Many audits are conducted due to the types of deductions claimed, such as the Child Tax Credit, Additional Child Tax Credit, Earned Income Tax Credit, or the American Opportunity Credit – credits for which you as the preparer are required to perform due diligence by asking and recording all of the required questions and your client’s answers.
You don’t want to be in the position of having to defend the tax return you prepared while at the same time defending your client – especially if it turns out that the information they provided to you during your preparation interview does not match the documentation they produce for the audit. If your client is found to have an underpayment that can be attributed to a substantial understatement of income tax, you could be subject to preparer penalties.
To avoid these penalties, you must support the position that lead to the substantial underpayment with “substantial authority” sources, such as the IRS code, statutory provisions, regulations, etc. You should carefully review your client’s case before deciding what works in both your best interest and your client’s best interest.
Despite the IRS Restructuring and Reform Act of 1998 offering a type of attorney-client privilege for nonattorney tax practitioners, attorney-client privilege does not apply to the preparation of tax returns. This is because tax returns are designed to be disclosed to a third party, such as the IRS or a state tax agency.
While lawyers are offered attorney-client privilege regarding tax returns because they cannot be forced to produce documents, the same is not offered to you, the preparer. If a client discloses certain information that they might not want to disclose to the government, you are not protected by attorney-client privilege and must divulge that information to the authorities.
If your client wants to maintain attorney-client privilege, your communications about tax preparation must be kept separate from communications about tax representation. When you have a busy schedule and numerous tax returns and cases on your plate, it can be easy to forget this rule.
Time and Resources
The length of time it takes to resolve an audit ranges depending on the complexity of the audit, the type of information requested, and the availability for meetings of both the client under audit and the IRS or state tax agency.
When you discover your client is under audit, it’s important to determine how far into the audit cycle the client is. Have they just been contacted? Do you have 30 days to respond to the initial notice and an opportunity for an extension, or have they reached the Notice of Deficiency stage where there is only a set 90 days left to resolve the case?
From there you should research what portion of their return is under audit, followed by what steps you need to take to resolve the issue. Despite needing a number of qualifications to represent your client, you must also question whether you have the “necessary competence” to defend your client to the IRS.
Under Circular 230, you must be knowledgeable and possess the skills necessary for the tax areas you’re working within and the relevant areas of the tax law. If your client’s issue is featured in the Audit Technique Guides published by the IRS, these can be a helpful resource for understanding what to expect and how to prepare for an IRS audit.
With an already busy schedule, you will want to weigh the costs of adding on to your workload with a strict timetable, research, preparations, and numerous meetings versus what you could do by spending that time on the more profitable aspects of your business.
Your client may display a number of emotional signs of stress, including anger, anxiety, and even depression, once they’ve received notice from the IRS or state taxing agency that they are being audited. It’s even possible they may incorrectly blame you.
You might feel obligated to handle their audit at no cost because they are a longtime client or because you want to preserve the relationship. The reality is, audits are costly and can take years to resolve.
The cost of an audit can range from a few hundred to tens of thousands of dollars, and the time they take to resolve can be just a few hours to weeks of your time. It’s possible your client requires more than your skill set and might be better represented by an attorney, which can drive up the cost considerably.
Using a Third-Party Audit Defense Service
A third-party audit defense service handles an audit from the time the client is contacted by the IRS or state taxing agency through to its resolution, all while keeping you informed of the progress.
According to a survey we conducted in 2016 of 122 tax professionals, we found that 90 percent were unaware that such services existed, though 33 percent said they would consider outsourcing audit and notice work. A further 24 percent had no concerns about outsourcing their audit and notice work, and actually saw that offering audit defense services demonstrated accuracy and confidence in the returns they prepared.
A multitude of factors should be taken into careful consideration before outsourcing your audit and notice work to a third party. Any firm you select must be able to provide the same level of care and security you provide to your clients, and should be an extension of the service you already offer.
They should handle state and federal audits, and should include attendance at face-to-face meetings with examiners. The firm should also offer a secure portal for uploading, communicating, and storing your client’s information.
While it might be tough to turn the reins over to someone else for a client who you’ve worked with personally, sometimes it’s in both your interest and your client’s interest to allow them to work with a third-party audit defense service.