"I think this is a textbook conflict of interest situation and you need to immediately disengage from one (or both) parties."

Is that because his income tax depends on the deduction that she takes. And her tax depends on the income he reports?

so, if her books have recorded her contract labor deduction. And that deduction is higher than the income he reports, then there is a conflict.  I see that.

But I can't audit them so maybe disengagement is the best.