Ethical issues in professional tax practice.

Powell, Richard ; Bolt-Lee, Cynthia E.

CASE DESCRIPTION

The primary subject matter of this case concerns the pressure placed upon today's tax professional by both the client and the firm to minimize tax liabilities through aggressive tax positions. Secondary issues include the competitive environment of professional tax practice, incentives to maximize revenue by retaining old and recruiting new clients, challenges facing the entry-level tax professional, and compliance with Circular 230 and the AICPA's Statement on Standards for Tax Service (SSTS). The case is appropriate for all introductory level tax students at both the undergraduate and graduate level and has a difficulty level of five: appropriate for first year graduate students. The case is designed to be taught in one class period and should require approximately three hours of outside preparation by students.

CASE SYNOPSIS

Students are placed in the role of inexperienced tax practitioners who must deal with aggressive clients wanting to minimize their tax liability. The student must analyze several tax issues, determine the appropriate tax treatment, and address the technical and ethical limits on the tax positions a CPA can take. Students must address numerous sanctions including penalties, malpractice claims, expulsion from the AICPA, loss of a CPA license, and even imprisonment.

As a recent college graduate with an accounting degree, a CPA license, and membership in the AICPA, the student, in a role play, is a recent hire at a regional CPA firm, Burst and Packend. The CPA has spent two years mostly in auditing, has obtained the experience necessary for licensing, but has decided to move into the tax department for a trial run. It is March 2009 and the CPA is meeting, for the first time, John and Mary Smith, who are coming in for an appointment to discuss their return. The supervising partner encourages development of an excellent relationship with the Smiths because they have been good clients who have paid high fees over the years. An audit manager, called upon to help during last year's heavy tax season, prepared their 2007 tax return. The Smiths tend to be aggressive in seeking deductions and minimizing their tax liabilities. They have dropped off various tax documents for review prior to their appointment.

TEACHING CASE: THE SMITHS

As a recent college graduate with an accounting degree, a CPA license, and membership in the AICPA, you are currently employed at the CPA firm, Burst and Packend. For the past two years you have worked in auditing and have now decided to move into the tax department for a change of scenery. It is March 2009 and today you are meeting, for the first time, John and Mary Smith, who are coming in for an appointment to discuss their return. Your supervising partner encourages you to develop an excellent relationship with the Smiths because they have been good clients who have paid high fees over the years. An audit manager, called upon to help during last year's heavy tax season, prepared their tax return in 2007. The Smiths tend to be aggressive in seeking deductions and minimizing their tax liabilities. They have dropped off various tax documents for your review prior to their appointment.

John Smith is a professor of art at the local private university and works on the side as a commissioned portrait artist. He has an office at the university. Mary is a marketing executive. The client file indicates their combined 2007 adjusted gross income was $200,000.

Mary has been attending evening classes in the university's law school. She finds the law courses helpful in her work as a marketing executive because she is very active in contract negotiations. In her second year of law school, tuition and related expenses are running $20,000 per year. On last year's tax return, the couple deducted the tuition as an itemized deduction for education expenses.

Although John has an office at the university, he has set up a home office where he can work on his academic research. The office includes an area that he uses as a studio for his commissioned paintings. By working at home, he is able to spend more time with the couple's young daughters. On their 2007 tax return, the Smiths deducted $5,000 for the home office. They hope to deduct similar amounts for 2008. The room includes a pullout sofa for occasional guests and a computer area for the personal use of his wife and a daughter. He has included the cost of paints and other supplies as part of his expenses as well as the cost of a top-of-the-line camera that he uses to take the portrait pictures from which he paints. The camera is used for personal purposes as well as for his art work. John also teaches group art lessons in his home studio. His earnings are $25,000 and his business continues to earn a profit. One major deduction was for travel. John studied in France during the year taking art classes focusing on portraiture, which he indicates will not only benefit his work as a portrait artist but also his work as a professor at the university. His sales brochures state that he has been formally trained abroad.

In connection with her work, Mary frequently drives her car from her downtown office to meet with purchasing agents and occasionally stays overnight near the agent's office prior to meetings the next day. For trips in the local metropolitan area, her employer does not reimburse her for mileage, much to her annoyance. Mary does not maintain detailed mileage records. She estimates her business mileage over the entire year and in the past has claimed an itemized deduction for transportation expenses.

The Smiths are fortunate to have a friendly neighbor, Brian Westbrook, who runs a private daycare. For years, Brian has allowed the Smith girls to attend at no cost in return for several of John's paintings. The Smiths believe this arrangement, worth approximately $8,000 in 2008, has no tax implication, and it was not reported on their 2007 tax return.

When the Smiths appear at your office, they say that they went to Las Vegas in 2008 to attend one of John's academic conferences and lost $3,000 gambling. John's school paid for his trip at a cost of $1,800, which excludes Mary's plane ticket and any of her separate costs. Mary comments, "We were better gamblers in 2007 when we won $4,000. At least we can deduct this year's loss on our tax return." When you review the 2007 return, the income items do not include gambling income.

John then comments, "You folks are so good at getting us tax refunds, why don't we make your fee equal to 20% of our refund for 2008. That way, you have lots of incentive to find us all possible deductions. We have never been audited, but I still really like your firm's ad in the newspaper saying "We win when the IRS audits our clients. For peace of mind, come to Burst and Packend."

Richard Powell, Pepperdine University

Cynthia E. Bolt-Lee, The Citadel