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Annette Nellen
Lessons From Obama Nominee Tax Problems

What lessons can be learned from the mistakes discovered on tax returns of some of the individuals nominated for positions in the Obama administration?

April 9, 2009
by Annette Nellen, CPA/Esq.

A startling aspect of the start of President Obama's administration was the seemingly regular news stories of some nominee owing back taxes. The errors were on both self-prepared and practitioner-prepared returns. Some errors seem to be due to inadequate attention paid by the taxpayers while some may be due to tax law complexity. These problems raise the question as to whether return preparers are asking the right questions and seeking sufficient documentation. This article reviews the tax problems as well as guidance on the preparer's role in verifying information and asking questions. Techniques are suggested that may enable preparers to lessen the chance of taxpayer and preparer penalties due to errors – as well as embarrassment should the public spotlight ever shine on the tax returns as it did for the nominees.

The Tax Error Saga

Treasury Secretary Geithner owed over $42,000 of taxes and interest over four years mostly due to failure to pay self-employment tax on earnings. He had been audited on more recent years and paid tax and interest on the same issue. (Senate Finance Committee information (PDF)). Soon thereafter, the nominee for chief performance officer withdrew due to a tax lien related to employment taxes. Former Senator Daschle also withdrew his nomination for Secretary of Health and Human Services after paying over $120,000 of taxes and interest from failure to report income in the form of a car and driver. (Deborah Tedford, "Tax Woes Derail Daschle's Bid for Health Chief," NPR, 2/3/09).

Problems continued with U.S. Trade Representative nominee Ronald Kirk's unreported income from speaking fees and a few other errors. The fees were donated to charity and incorrectly omitted from the return as a wash rather than as income and a charitable deduction. (Senate Finance Committee memo 3/2/09 (PDF)).

The last nominee for Health and Human Services - Kathleen Sibelius, also discovered errors on self-prepared returns. The errors included failure to find letters to support three of 49 charitable donations of $250 or more. (Brian Montopoli, "Another Obama Nominee Has Tax Issues," CBS News Blog, 3/31/09).

Nature of the Problems

The tax errors uncovered during the nominee vetting process can be grouped as follows:

  • Overlooked income, such as due to a missing 1099 or income not reported on a Form W-2 or 1099.
  • Missing documentation, such as for charitable contributions or entertainment expenses.
  • Lack of preciseness in the law, such as how to allocate tax preparation fees between Schedule A and Schedule C or E.
  • Insufficient research, such as misclassifying overnight camp expenses as qualifying for the dependent care credit or not reporting income donated to charity.
  • Insufficient attention to other taxes, such as employment taxes on household help.

Talk in the press and on blogs questioned whether the tax problems were just a sign of tax law complexity. Arguably, some errors, such as overlooking a Form 1099, are not due to the complexity of the law, but perhaps to complexity of one's work situation. Some errors, such as inadequate documentation for charitable contributions or thinking that both overnight and day camp qualify for the dependent care credit, are due to complexity. However, additional research, time and attention might have caught these errors prior to filing. But, how much time is needed to generate an error-free return and is such a goal achievable?

Guidance on Tax Return Preparation Diligence

Guidance on the IRC §6694 preparer penalty, as well as in Circular 230 and the AICPA Statements on Standards for Tax Services (SSTS), addresses when a preparer can rely on taxpayer information without verification. For example, Revenue Procedure 80-40 provides:

"The penalty under section 6694(a) generally will not apply where a preparer in good faith relies without verification upon information furnished by the taxpayer. Thus, the preparer is not required to audit, examine or review books and records, business operations, or documents or other evidence in order to verify independently the taxpayer's information. However, the preparer may not ignore the implications of information furnished to the preparer or which was actually known by the preparer. The preparer shall make reasonable inquiries if the information as furnished appears to be incorrect or incomplete. Additionally, some sections of the Code require the existence of specific facts and circumstances, such as maintenance of specific documents, before a deduction may properly be claimed. The preparer shall make appropriate inquiries to determine the existence of facts and circumstances required by a Code section or regulations as a condition to claiming a deduction."

Despite this 1980 ruling pre-dating changes to §6694 by the Budget Reconciliation Act of 1989 (P.L. 101-239, 12/19/89), its approach is followed in other guidance. Circular 230, §10.34(d) provides that practitioners may "rely in good faith without verification upon information furnished by the client." However, practitioners may not ignore "implications of information" they are aware of and "must make reasonable inquiries" when the information does not seem valid or complete. (T.D. 9359 (PDF), 2007-45 IRB 931, 942).

SSTS No. 3, Certain Procedural Aspects of Preparing Returns, is similar to the above language. It also notes the need to refer to a client's prior year tax returns "whenever feasible." If a tax rule conditions deductibility on maintenance of particular documentation, the preparer "should make appropriate inquiries to determine" that the requirements are satisfied. Clients should be encouraged to submit documentation "where appropriate." Preparers should consider information furnished to them from the client and third parties.

SSTS No. 3 reminds AICPA members that despite their responsibility to exercise due diligence in return preparation, "the taxpayer has the ultimate responsibility for the contents of the return."

Suggestions for Avoiding Errors

While complexity of the tax law and transactions makes it difficult to make all returns error-free, here are a few suggestions that may help:

  • Checklists: A checklist for verifying various elements of taxable income, credits and other taxes can help catch errors as well as missed opportunities for deductions and credits. The AICPA Tax Section provides its members with extensive checklists.
  • Frequent reminders to clients: Proper computation of federal and state income tax liability and any other taxes a client may owe, such as employment taxes on household help, requires attention throughout the year, not only when gathering tax records after year end. Frequent reminders to clients about what type of documentation is needed to claim charitable contributions, business expenses, dependent care credits, energy credits, and more, will serve both to help clients understand the tax law and have appropriate documentation.
  • Have a technique to help find "unusual" items: How is a preparer to know that a client is provided a car and driver if it doesn't show up on a W-2 or 1099? One possibility is to provide clients with brief scenarios of "typical" transactions and ask if they have anything that doesn't fit that fact pattern. For example:
    • Employment: Typically, employees are paid a cash salary and fringe benefits such as health care. If you received anything else from your employer, please let us know.
    • Income: Most individuals receive income in the form of wages, interest and dividends. If you received any other types of payments, such as from consulting, speeches, odd jobs, online sales, auctions, or gambling, please let us know.
  • Engagement letters: These should include the reminder from SSTS No. 3 that clients are responsible for the contents of their return.
  • Office education: It is important that all return preparers in an office be familiar with the guidance noted earlier and be aware of the office procedures for when documentation should be reviewed and how to identify and handle situations that just don't look right.

Summary

While shocking and disappointing, the news of tax return errors serves as a useful reminder to tax practitioners to review their practices and make adjustments to be sure clients don't have the types of problems that made headlines for recent nominees.

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Annette Nellen, CPA/Esq., is a tax professor and Director of the MST Program at San José State University. She is also a fellow with the New America Foundation. Nellen is an active member of the tax sections of the AICPA and ABA. She has several reports on federal and state tax reform and a blog.