Your tax return was selected for audit. The auditor reviewed your information and disallowed some of your deductions. As a result, you owe additional taxes including penalties and interest. How could this happen? You been using a trusted CPA for years to prepare your tax returns.
You should be aware that you are 100% responsible for everything reported on your tax return. Your trusted CPA only has to exercise due diligence. So what does this mean?
The objective meaning of due diligence is the diligence or care that a reasonable CPA would use under the same circumstances.
IRS Circular 230 defines Due Diligence as the following:
A CPA must exercise due diligence
1) In preparing or assisting in the preparation of, approving, and filing tax returns, documents, affidavits, and other papers relating to IRS matters;
2) In determining the correctness of oral or written representations made by the CPA to the IRS; and
3) In determining the correctness of oral or written representations made by the CPA to clients with reference to any matter administered by the IRS.
Did I lose you yet?
Basically, your CPA can on most occasions rely in good faith and without additional verification on information provided by you. This is true for most circumstances but there are exceptions when your CPA is required to ask additional questions.
For example, your CPA provides you with an organizer. You fill out the organizer. You provide your CPA with the filled out organizer and a profit (loss) statement for your business. Generally, your CPA can use the information provided to prepare your tax return without asking any additional questions. You may have included some deductions in your organizer or profit (loss) statement that you are not sure about such as the cost of life insurance premiums as a business expense. The cost of life insurance premiums is included in your the total amount of insurance costs paid in the year. The cost of life insurance premiums purchased for the owner or officers of the company are not deductible. If you do not bring this particular issue to your CPA’s attention, the CPA can include all the insurance expenses reported by you as a business deduction. If your tax returns is later audited, you will be responsible for the additional tax, interest and penalties due to the IRS disallowing the life insurance expense. Not your CPA. Your CPA relied in good faith on the information provided by you.
Items needing additional verification
There are instances when the CPA should ask for additional verification. Your CPA should ask for additional verification for expenses requiring additional substantiation such as Travel, Entertainment and Meal expenses. If you are claiming Entertainment business expenses, your CPA should ask you if there are records showing the amount, time, the place, business purpose, and your relationship to the persons entertained. An other example is if you have a home base business but you are claiming 50,000 business miles. The CPA should ask for additional verification such as a log book.
It is our recommendation not to blindly provide your CPA with your tax information expecting your CPA to properly report all the information correctly on your tax return. Ask questions and communicate with your CPA often. Review your tax return after the return is prepared. You should have some understanding on the information reported on your tax return.
IRS Circular 230 Disclosure: To the extent this writing contains advice on a federal tax issue, the advice is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed in this communication.