1.0 Ethics, Professional Responsibilities and Federal Tax Procedures REG Practice Quiz

• A. Attorneys, certified public accountants (CPAs), and enrolled agents, all three hold unlimited practice rights before the IRS
• B. Any individual who prepares a tax return for compensation, paid preparers automatically have full IRS representation rights
• C. Only enrolled agents, CPAs and attorneys must obtain a separate IRS credential to practice before the IRS
• D. Family members and legal guardians, immediate family members can represent taxpayers without any credential

Treasury Circular 230 (31 CFR Part 10) governs practice before the Internal Revenue Service. Three categories of professionals have UNLIMITED practice rights, they may represent clients before any office of the IRS, including audits, Appeals, Collections, and the Taxpayer Advocate Service: (1) Attorneys: admitted to practice law in any US state; (2) Certified Public Accountants (CPAs): licensed by a state board of accountancy; (3) Enrolled Agents (EAs): federally authorized tax practitioners who have either passed a comprehensive three-part IRS examination or have qualifying IRS experience. Additional categories with limited rights: enrolled actuaries, enrolled retirement plan agents, and Annual Filing Season Program completers.

• A. The Internal Revenue Code (IRC), as enacted by Congress under its constitutional taxing authority, the IRC is the primary statutory source of federal tax law
• B. Treasury Regulations, regulations are the IRS's official interpretation of the IRC and are the most authoritative source of tax law
• C. Revenue Rulings, the IRS's published positions on specific factual situations represent the highest authority
• D. IRS Publications and Instructions, these represent the IRS's official guidance to taxpayers and are binding on all parties

The complete hierarchy of federal tax authority (highest to lowest): (1) US Constitution, supreme law, grants Congress taxing authority; (2) Internal Revenue Code (IRC), enacted by Congress pursuant to Constitutional authority; primary statutory source; (3) Treasury Regulations. Treasury/IRS interpretation of IRC; generally binding; (4) Revenue Rulings, IRS official positions on specific fact patterns; (5) Revenue Procedures, IRS procedural guidance; (6) Private Letter Rulings, binding only on the requesting taxpayer; (7) IRS Publications, informational only; not binding. The IRC ranks at the top of the administrative sources because it is an Act of Congress, only a court ruling or Congressional amendment can override it.

• A. No penalty applies, a 25% probability of success satisfies the 'realistic possibility of success' standard that applies to all tax return positions
• B. The CPA is potentially subject to the §6694(a) penalty because a 25% probability does not meet the 'substantial authority' standard (approximately 40%+ probability) required for non-disclosed positions on non-tax-shelter items
• C. The CPA is potentially subject to the §6694(b) penalty for willful understatement, because any position with less than 50% chance is considered willful
• D. No penalty applies to CPAs, §6694 only applies to enrolled agents and non-credentialed preparers, not to licensed CPAs

Section §6694(a) imposes a penalty on a tax return preparer for understatement of a taxpayer's liability due to an UNREASONABLE POSITION. For a non-disclosed, non-tax-shelter position, the standard is SUBSTANTIAL AUTHORITY (approximately 40%+ likelihood of success if challenged). A 25% probability does not meet the substantial authority threshold. Penalty: the GREATER of $1,000 or 50% of the income derived by the preparer from the return with the unreasonable position. Exceptions: the preparer can avoid the penalty by making adequate disclosure of the position on the return AND the position has a reasonable basis (approximately 10%+ probability). If the position were disclosed (Form 8275), the lower 'reasonable basis' standard would apply and 25% probability might satisfy it. The CPA's failure to disclose triggers the higher substantial authority requirement.

• A. Penalty = $6,000 (75% × $8,000); reasonable cause is not a defense to accuracy-related penalties
• B. Penalty = $1,600 (20% × $8,000); reasonable cause and good faith reliance on a tax advisor could eliminate the penalty
• C. Penalty = $1,600 (20% × $8,000); the penalty cannot be avoided because negligence is per se unreasonable
• D. Penalty = $3,200 (40% × $8,000); the gross valuation misstatement rate applies to all substantial understatements

Section §6662 accuracy-related penalty: 20% × $8,000 understatement = $1,600. The §6662 penalty covers multiple components, when both negligence and substantial understatement apply, the penalty is NOT stacked (only one 20% penalty applies to the full underpayment). Reasonable cause exception (§6664(c)): the §6662 penalty does not apply to any portion of an underpayment if: (1) there was reasonable cause for the underpayment; and (2) the taxpayer acted in good faith with respect to that portion. Examples of reasonable cause and good faith: reasonable reliance on the advice of a qualified tax professional who had all relevant facts; a taxpayer's reasonable, good-faith interpretation of an ambiguous rule. The practitioner's advice must be independent (not generated by the taxpayer) and based on full disclosure of facts to qualify as a defense.

• A. No, under the privity rule (Ultramares doctrine), the CPA is only liable to ABC Corporation since the bank was not in contractual privity with the CPA
• B. Yes, under the majority rule, the CPA is liable to third parties who are members of a specifically foreseen and limited class of persons whom the auditor knew would rely on the financial statements for a specific transaction
• C. No, CPAs are immune from third-party lawsuits unless the third party is specifically named in the engagement letter
• D. Yes, under the most liberal (minority) foreseeability rule, the CPA is liable to any foreseeable user of the financial statements without limitation

The majority rule follows the Restatement (Second) of Torts §552 approach: a CPA is liable for negligent misrepresentation to third parties who are members of a LIMITED AND FORESEEABLE CLASS, specifically, persons for whose benefit and guidance the information was supplied, and who the CPA knew (or reasonably should have known) would rely on it for a specific transaction. Analysis: If the CPA knew that ABC Corporation intended to use the financial statements to obtain a bank loan (specific use for a specific class of lenders), the bank falls within the foreseeable class and the CPA may be liable even without privity. If the financial statements were for general use and the CPA had no knowledge of the bank's specific reliance, liability may be limited. This contrasts with: (a) Ultramares (strict privity, most restrictive); (b) Foreseeability rule/Rosenblum v. Adler (most liberal, any reasonably foreseeable user).

• A. $60 total, there is one combined penalty for all administrative failures regardless of the number of violations
• B. $6,000 total, the penalty is $2,000 per violation per return for each administrative failure
• C. $180 total, §6695 imposes a separate $60 penalty for each distinct failure (failure to sign, failure to retain copy, failure to provide copy to taxpayer)
• D. No penalty, administrative failures by a preparer are not subject to penalties under §6695 unless the taxpayer suffers actual monetary harm

Section §6695 imposes the following separate penalties on tax return preparers for administrative failures (each $60 per return as of 2023, subject to annual inflation adjustments): (1) §6695(a): failure to furnish a copy of the return to the taxpayer, $60 penalty; (2) §6695(b): failure to sign the return, $60 penalty; (3) §6695(d): failure to retain a copy or list of returns prepared, $60 penalty; (4) §6695(c): failure to provide identifying number (PTIN), $60 penalty; (5) §6695(e): failure to file information returns, $60 per failure. For the three violations described (failure to sign + failure to retain + failure to furnish copy): 3 × $60 = $180 maximum penalty. The maximum penalty for §6695 failures in any calendar year is generally limited to $30,000 per category, preventing catastrophic penalties for high-volume preparers who make systematic errors.

• A. $30,000 (20% × $150,000), the standard accuracy-related penalty rate applies to all underpayments
• B. $150,000 (100% × $150,000), fraud requires full repayment of the tax as a penalty
• C. $112,500 (75% × $150,000), the civil fraud penalty under §6663 is 75% of the underpayment attributable to fraud
• D. $500,000, the civil fraud penalty equals the unreported income, not the tax on it

Section §6663 civil fraud penalty: 75% × underpayment attributable to fraud = 75% × $150,000 = $112,500. Key aspects of §6663: (1) Rate: 75% of the portion of the underpayment attributable to fraud; (2) Burden of proof: the IRS bears the burden of proving fraud by clear and convincing evidence; (3) Effect: if fraud is established for any portion, the entire underpayment is treated as fraudulent (unless the taxpayer can establish that part of the underpayment is not due to fraud); (4) No reasonable cause defense: unlike §6662, there is no reasonable cause exception to §6663; (5) Criminal vs. civil: §6663 is a CIVIL penalty; criminal tax fraud under §7201 is separate and can result in imprisonment and additional fines; (6) Statute of limitations: no statute of limitations applies to fraudulent returns, the IRS can assess deficiencies at any time.

• A. No compliance issues exist, contingent fees are always permissible for Tax Court representation, and practitioners may share client files with third parties upon request
• B. Circular 230 prohibits ALL contingent fee arrangements for practitioners in any tax matter; sharing the file without client consent violates confidentiality obligations
• C. The contingent fee is permissible only if it does not exceed $50,000 and the practitioner files a disclosure statement with the IRS; confidentiality rules allow disclosure to third parties for billing purposes
• D. Circular 230 generally prohibits contingent fee arrangements for preparing original returns and other non-contested matters, but permits contingent fees in proceedings before courts (Tax Court) and in connection with IRS examination matters where the IRS has raised an issue; the practitioner must obtain client consent before disclosing client information to third parties

Circular 230 analysis: (1) Contingent fee in Tax Court proceeding: §10.27 permits contingent fees for 'representation before a court' and for 'refund claims filed after the IRS has notified the client of an examination.' Representation in Tax Court qualifies, the $50,000 contingent fee is PERMISSIBLE in this context; (2) Confidentiality: §10.20 and §10.28 of Circular 230 require practitioners to protect confidential client information. The client's tax information may not be shared with third parties without: (a) the client's informed consent, (b) a legal requirement or court order, or (c) to comply with applicable law. A third-party request alone does not authorize disclosure, the practitioner must obtain the client's written consent before sharing the tax file.