What to tell clients about amended returns

At one time, a popular consumer financial magazine ran an annual feature in which accountants were asked to prepare a tax return for a hypothetical couple. And year after year, no two practitioners calculated the “correct” tax liability. Moreover, the results they did come up with often varied by tens of thousands of dollars. True, the hypothetical returns they were asked to prepare were designed to be especially tricky. However, the fact of the matter is that mistakes can crop up, even on run-of-the-mill returns.

At this time of year, tax return preparers frequently detect errors on prior years’ returns. For example, a cross-check of a client’s 2021 return against returns for prior years may reveal unreported income or a missed deduction for an earlier year. In addition, there will inevitably be clients who show up after their 2021 returns have been filed, waving a misplaced 1099 or a stack of receipts for a deduction that was not claimed on the return.

Nobody’s perfect. There may be situations where mistakes were made in preparing a client’s return. For example, miscalculation of the holding period for an asset may have turned a long-term gain into less favorably taxed short-term gain. A misapplication of a phase-out limit may have cost the client all or part of a deduction.

Practice tip: A review of returns for open years can be an enticing “value added” service for new clients. You’ll probably want to offer this service gratis in connection with the preparation of the current year’s return. But, of course, you will want to charge a fee for correcting any errors you catch.

Preparer responsibilities

In some cases, it may be tempting to let sleeping dogs lie, especially if correcting a return error will produce a negligible difference in a client’s tax for the year. However, Treasury Circular 230, the official code of conduct for practice before the IRS, requires a preparer to “advise the client promptly” of an error. The AICPA’s Statements on Standards for Tax Services (SSTS), which interpret and expand upon Circular 230, provide that when informing a client of an error, a practitioner should recommend the proper measures to be taken. Moreover, the SSTS makes it clear that the duty to inform clients of a return error applies regardless of whether the preparer who caught the error actually prepared the return in question.

Some clients may be reluctant to correct a return error. In the case of underreporting, a client may want to play the odds and wait and see if the IRS picks up on the error. And even if a correction will result in a refund, a client may believe that filing an amended return will prompt a full-scale IRS audit. In advising clients, you should point out that promptly correcting an underreporting error will reduce the amount of interest and penalties payable on the deficiency. On the other hand, clients should be advised not to pass up legitimate tax write-offs out of fear of the IRS. The IRS maintains that an amended return will not automatically trigger a minute inspection of a taxpayer’s return.

In any case, the decision whether to correct a tax return error ultimately rests with the client. According to the SSTS, a practitioner has no duty to inform the IRS of a return error and may do so only with the client’s permission “except where required by law.” On the other hand, the SSTS states that when a client refuses to correct an error that has more than an insignificant impact on their tax liability, a practitioner must consider whether to withdraw from preparing the client’s returns and whether to continue a professional relationship with the client. If a practitioner determines that it is not necessary to sever relations with the client, the SSTS emphasizes that the practitioner must take reasonable steps to ensure that the error is not repeated.

A preparer’s financial liability for a tax return error is not clear cut. From the IRS’ point of view, any unpaid tax, interest, and penalties are the taxpayer’s responsibility, regardless of who made the error. However, an irate client who is advised of a mistake on their return may seek to hold the preparer financially responsible—and, of course, the client may object to the fee for preparing the return. To avoid disputes, many preparers use tax return engagement letters specifying the limits on the preparer’s liability for return errors.

On the flip side, a missed deduction or credit generally does not present a liability issue. In most cases, a client will be made whole when they receive a refund plus interest. This assumes, of course, that the error is corrected in a timely fashion. At least one court has held a practitioner liable for damages when they missed the deadline for filing an amended return claiming a refund. Therefore, it behooves a practitioner to act promptly once an error is detected—and to pay close attention to the requirements for filing amended returns.