How the Tax Court Sank a Tax Prep Practice

IRS criminal investigations
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It’s not just taxpayers who are at risk for filing tax returns with fraudulent entries.

A tax professional who “aids and abets” a taxpayer committing fraud, or is involved with fraud on his or her own, is also on the IRS’ radar.

Consider the significant implications for the tax return preparer in one new case, Kapp TC Memo 2019-84, 7/9/19, who prepared thousands of inaccurate tax returns for mariners. You can find a summary of the IRS penalties that may be assed against professional tax return preparers here.

For example, the penalty for aiding and abetting an understatement of tax liability is $1,000 or $10,000 if the conduct relates to a corporate tax return. The penalty applies once for documents relating to the same taxpayer for a single tax period or event. Similarly, if a tax return preparer is convicted a felony, the maximum penalty is $100,000, or $500,000 relating to a corporate tax return, imprisonment of up to three years or both (together with the costs of prosecution).

In the new case, the tax preparer operated a firm in California specializing in returns for mariners like deep-sea sailors and tugboat captains. During the tax years in question—from 2000 through 2006—the owner and his employees prepared thousands of tax returns and/or schedules for mariner taxpayers.

The tax returns and schedules consistently claimed expense deductions for meals and incidental expenses using revenue procedures permitting taxpayers to deduct meals and incidental expenses paid or incurred without substantiating the amount. It was standard operating practice of marine companies.

Some of the tax return preparer’s mariner clients were involved in Tax Court litigation relating to the deductibility of meals and incidental expenses. While the Court held that mariner taxpayers were entitled to deduct incidental expenses incurred while at sea, it denied deductions for business meals they did not pay for.

Nevertheless, the office continued to prepare returns and schedules claiming the meal deductions and it advertised this benefit. Following an IRS investigation, the tax return preparer was advised in writing by his counsel that there was little if any authority which would permit a mariner taxpayer to use the revenue procedures to deduct the cost of meals furnished by the employer.

Despite this advice, he still prepared returns and schedules claiming the deductions. Eventually, the IRS enjoined the tax return preparer from making this claim, stating that the so-called “mariner tax deduction” was illegal and in violation of the tax law.

The preparer filed a 117-page client list naming more than 5,000 taxpayers he said were entitled to deductions. After extended legal battles, the IRS assessed penalties based on the 5,000 + returns and/or schedules for the period 2000 through 2006. Now the Tax Court has ruled that the IRS has met its burden of proof and the penalties totaling more than $3.2 million will be enforced.

Lesson to be learned: If you’re going to the mat with the IRS on this type of issue, make 100 percent sure that you’re on firm ground. Avoid conflicts that potentially could sink your practice. Adhere to the strict letter of the law and your business will continue to thrive.

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About Ken Berry

Ken Berry

Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a wide variety of newsletters, magazines, and other periodicals.           

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