|Obligations of Taxpayers and Tax-Return Preparers Regarding Amended Returns
What are the obligations of a taxpayer to file an amended return to correct an error in a previously filed tax return for an open year and of a tax return preparer to so advise?
October 15, 2009
Inevitably taxpayers make good-faith mistakes in preparing their returns, which result in erroneous determinations of the tax due. As a further complication, the errors may impact subsequent years' returns. Upon discovery of an error after a return is filed what are the obligations of the taxpayer to file an amended return to correct the error and what are the obligations of the tax return preparer to so advise? In those cases where the error impacts a subsequent year's return, the additional question arises as to whether the subsequent year's return is determined using the facts as then known to be true?
Legally, taxpayers are required to accurately compute and report their income, deductions, credits and tax liability on a timely filed return. However, there appears to be no authority in the Internal Revenue Code (IRC), the regulations or case law that imposes a legal duty on a taxpayer to file an amended return to correct an error or omission on a return previously filed. This is true regardless of whether the error omission has resulted in an understatement of tax due or whether the statute of limitations is still open with respect to that year.
Although the Code does not contain provisions with respect to amended returns, there are numerous references to amended returns in the regulations. These provisions provide that an amended return can only be considered if the original return was not fraudulent. Reg. Sections 1.451-1(a) and 1.461-1(a) provide that if a taxpayer discovers with respect to a prior open year an omission of an item of income or an improperly claimed deduction, the taxpayer "should" (not "must" or "shall") file an amended return and pay the resultant tax due. Commentators have written that the use of "should", rather than "must" or "shall" indicates that the filing of an amended return is not mandatory, but advisable. See What Obligations Do Taxpayers and Preparers Have to Correct Errors on Returns? by Pollack, 72 JTAX 90 (February 1990).
IRS Publication 17, Your Federal Income Tax has long provided that a taxpayer should correct his or her return, if after it is filed, the taxpayer finds that "[he or she] did not report some income [or] [he or she] claimed deductions or credits [he or she] should not have claimed". The publication also states that the taxpayer use Form 1040X to correct an already filed return. Here again, "must" or "shall" is not used.
In Broadhead v. Commissioner, TC Memo. 1955-328, the Tax Court held that the Treasury Regulations do not require a taxpayer to file an amended return, even after advised by the taxpayer's accountant to file an amended return. In Broadhead, after the filing of the taxpayer's original return, the taxpayer's accountant had advised the taxpayer that his closing inventory accounts were incorrect. The IRS argued that the taxpayer "willfully and deliberately attempted to evade and defeat his income taxes when he refused to file an amended return after being advised to do so by his accountant." The Tax Court held that the taxpayer "was not required by statute to file an amended return and if one had been tendered for filing [the IRS] could have declined to accept it." In Badaracco v. Commissioner, 464 U.S. 386 (1984), the Supreme Court implicitly accepted Broadhead while dealing with a limitation period issue and stated that "the Internal Revenue Code does not explicitly provide either for a taxpayer's filing or for the Commissioner's acceptance of an amended return; instead an amended return is a creature of administrative origin and grace." The Supreme Court noted that although the regulations, including Reg. 1.451-1(a) and 1.461-1(a) refer to an amended return, no regulation requires the filing of an amended return.
Despite the references to amended returns in the regulations and IRS publications, a taxpayer is under no legal obligation to file an amended return to correct a good faith error in a prior open year. However, the taxpayer cannot take advantage of the error made in prior years in subsequent years. Otherwise the taxpayer will have violated the legal obligation to file a correct and accurate return using the facts and circumstances that are then known to be true. It is advisable that any correction of an item in a current return to account for an error in a prior return be revealed to the IRS in a short disclosure statement attached to the current year's return; otherwise, the taxpayer runs the risk that the IRS will claim that the taxpayer concealed the prior error by making an undisclosed adjustment.
Although there is no legal obligation on a taxpayer to file an amended return to correct an error in a prior, filed tax return, there are certain obligations upon the taxpayer's tax advisors upon discovery of the error. Circular 230, Section 10.21, governing the practice of tax advisors before the IRS, provides that if a tax advisor knows that a client has made an error in a filed return for an open year, the tax advisor is required to tell the client that the filed return is not correct and to advise the client of the consequences of the error or omission. However, Circular 230 does not require the tax advisor to advise the client to file an amended return or to withdraw from representing the client if the client does not file an amended return.
The AICPA Statements on Standards for Tax Services, No. 6, goes one step further. If a CPA discovers an error in a client's previously filed return, the CPA should inform the client promptly of the error and "the measures to be taken". The recommendation may be made orally. The Statements do provide that although there may be no legal obligation on the client to file an amended return, a CPA should consider whether the client's decision not to file an amended return may predict future behavior that might require termination of the professional representation. It is cautioned that a CPA should consult with his or her counsel before deciding on a course of conduct.
Most commentators feel that there is a legal and ethical requirement on a tax practitioner to advise the client to file an amended return. It is still an open question whether a tax practitioner should inform the client that there is no legal obligation to file an amended return. Such advise by an attorney must be based upon the attorney's "good faith belief" that there is a realistic possibility of success in litigating a challenge to the client's decision not to file an amended return in order to comply with Formal Opinion 85-352(1985) of the ABA Ethics Committee. Since there is no legal requirement to file an amended return, an attorney giving such advice would appear to fully satisfy the requirements of Formal Opinion 85-352(1985).
Until either the regulations are amended or legislation is enacted to impose a legal duty, a taxpayer is under no legal duty to file an amended return to correct an error in a previously filed return for an open year. Further, tax advisors need only inform the client of the error or omission and recommend to the client the measures to be taken.
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