LEGAL THOUGHTS – Managing IRS Due Diligence Investigations and Strategies for Compliance and Risk Mitigation
COLEMAN JACKSON, ATTORNEY & LEGAL COUNSEL | Transcription of Legal Thoughts
Posted on July 29, 2024
Topic: Tax Return Preparer Due Diligence
Attorney Introduction:
■Welcome to Legal Thoughts my name is Coleman Jackson, and I am an attorney at Coleman Jackson, P.C., a taxation, contracts, litigation and immigration law firm based in Dallas, Texas.
■In addition to myself, we have Legal Assistant, Leiliane Godeiro, Law Clerks, Ayesha Jain and Mlaah Singh, and Administrative Assistant, Michelle Gutierrez.
■On today’s “Legal Thoughts” podcast, our Law Clerk, Mlaah Singh, will conclude her interview of me today in our final episode of our Legal Thoughts podcast series on “Tax Return Preparer Due Diligence and Preparer Penalties. ” This is episode four in this series of Legal Thoughts podcasts. We urge our audience to follow our podcast and invite all their neighbors, friends and acquaintances to please tune in to this series of Legal Thoughts Podcasts on Apple Podcast, Google Podcast, Spotify or wherever you listen to podcasts.
–The four episodes in our Tax Return Preparer Due Diligence and Penalty Case Series are as follows:
1. Attorney’s Key Take Aways
2. Navigating Due Diligence Requirements by Paid Tax Return Preparers
3. Failure to Comply – Potential Consequences for Paid Tax Return Preparers and the Taxpayers, and
4. Managing IRS Due Diligence Investigations and Strategies for Compliance and Risk Mitigation
Interviewer Introduction:
Hi everyone, my name is Mlaah Singh and I am a Law Clerk at the tax, business structuring, contracts, litigation and immigration law firm of Coleman Jackson, Professional Corporation. Our law firm is located at 6060 North Central Expressway, Suite 620, right here in Dallas, Texas, 75206. Our English phone number is 214-599-0431 and our dedicated Spanish language line is 214-599-0432.
■Good afternoon Attorney; thank you for allowing me to interview you once again for Episode 4 of our Paid Tax Return Preparer Due Diligence Requirements and this apparent uptick in IRS examinations and investigations of Paid Tax Return Preparers. Today, we are going to close out this series with our final episode in the series where hopefully our Legal Thoughts audience will gain a clear understanding perhaps best practices in managing the IRS due diligence expectations and responsibilities that we have been discussing in Episodes One, Two and Three in this Paid Preparer Due Diligence Requirements podcast series.
Interviewer Comments: Mr. Jackson, before we begin, it may be helpful to understand the following.
Question Number One: How exactly does the IRS conduct due diligence investigations, and what triggers these investigations? What initial steps should a tax return preparer take if they are notified of an IRS due diligence investigation?
Interviewee: Coleman Jackson, Lawyer
ATTORNEY ANSWER – QUESTION 1
: Good afternoon Mlaah. First, I want to welcome our Legal Thoughts Podcast audience to our 4th and final episode in our Paid Preparer Due Diligence Requirements podcast series.
As for your first question: How exactly does the IRS conduct due diligence investigations, and what triggers these investigations? I can only answer this question from the perspective of representing tax return preparers or taxpayers who might have been a subject of an IRS Paid Preparer Due Diligence examination. Generally speaking over the years, Congress has required or imposed more-and-more tax positions where paid preparers must determine a taxpayer’s eligibility to claim the tax position. We have discussed these particular tax positions in our prior episodes in the podcast series. Internal Revenue Code Section 6695(a) imposes a duty on paid return preparers to determine a taxpayer’s eligibility to claim head of household filing status, the child tax credit, the additional child tax credit, other dependent credit and the American Opportunity Credit.
From discussions with IRS examiners from time to time while representing actual paid tax return preparers I have gleaned that the initial trigger to exam any particular return or paid preparer is likely triggered when an IRS computer flags the suspected return for further review. It sounds like then an actual IRS examiner will then physically examine the tax return and see whether applicable tax laws have been violated including Internal Revenue Code Section 6695(a). This investigation could lead to the IRS notifying the paid tax return preparer that they intend to do a Paid Preparer Due Diligence Examination under Code Section 6695(a). Also the IRS may notify the taxpayer that they are proposing an adjustment of their effected tax return. This is the typical pattern that we typically see when a paid preparer or a taxpayer comes into our office on an initial consultation. They usually come with this trigger letter in hand. Sometimes they come into our office after they have unsuccessfully attempted to resolve the matter without legal representation. Either way, it appears that the triggers for the exam are as I have mentioned: (2) the computer flags the return for further human review, (2) the human review leads to further investigation, and (3) further investigation leads to the paid preparer being identified for a paid preparer due diligence exam and their customers (or taxpayers) returns also being examined and possibly adjusted.
Other these general observations and triggers gleaned from talking to IRS examiners on actual client cases, I don’t have any inside information as to how the IRS targets or select paid preparers for examination. These due diligence requirements deal with tax position that could or perhaps are perceived to be ripe for tax cheating or perhaps even simple errors in computing the credits. And head of household status could possibly be a confusing area for many taxpayers and their customers. The IRS tend to target tax areas where there are tax compliance issues or confusion in the public.
As for your second question: What initial steps should a tax return preparer take if they are notified of an IRS due diligence investigation?
- The paid return preparer should take the mater serious and gather the necessary files referenced in the IRS Due Diligence Letter;
- The paid return preparer should seek the representation of a tax professional who can advocate and counsel you.
These two steps are critical from what I have seen in this practice area. Tax Preparers who are sloppy and unprepared can experience some serious penalties under Internal Revenue Code Section 6695(g) for violating due diligence requirements. Remember what I have said in previous episodes in this series: Paid tax preparers must demonstrate that they (a) know the facts about the taxpayer, (b) they must demonstrate that they computed the credits accurately based on those facts, (c) they must complete Form 8867, and (d) they must be create, maintain and produce contemporaneous records for three years. Multiple inflation adjusted penalties can be assessed on a single taxpayer’s return.
INTERVIEWER: Mlaah Singh, Tax Law Clerk
Interviewer Comment: I appreciate you distinguishing that your response to this question is based on your interactions with the matter as a lawyer. Therefore, it is important to hear about the potential faults of taxpayers and tax preparers within your experience. Thank you for giving a detailed explanation on the proceedings of tax due diligence investigations.
Question Number Two: Can you describe the types of information and documentation the IRS typically requests during a due diligence investigation, and how can preparers ensure they are adequately prepared?
Interviewee: Coleman Jackson, Lawyer
ATTORNEY ANSWER – QUESTION 2
Okay; let me go through some of the types of information that I have seen the IRS Due Diligence Examiner ask for during these Paid Preparer Due Diligence Examinations:
1.They usually will request to see a list of taxpayer files. But remember, a due diligence examination can be initiated by the IRS examiner visiting the Paid Return Preparer’s Office unannounced. In which case they could simply ask the preparer to allow them to review their tax return files for a selected examination period.
2.As for how a paid return preparer could be sure they are adequately prepared; well, paid tax return preparers should know the federal tax laws applicable to their clients, comply with those laws and document their compliance in contemporaneous client files.
- IRS examiners typically are looking for evidence and contemporaneous documentation that shows—
- the return preparer know the facts concerning their clients at the time the tax return was filed with the IRS,
- evidence that the return preparer created worksheets and documents evidencing how they computed the credits based on facts maintained in their files that they obtained from the taxpayer or third parties,
- the tax return preparer completed Form 8867 and maintained that form in the taxpayers files,
- Over all they are going to be looking at the quality of the files and the completeness of the files. Sloppy and incomplete files are very likely to lead to paid preparer due diligence penalties or controversies with the IRS examiner.
Finally, as I have mentioned in prior episodes in this paid preparer due diligence series, I have often seen the IRS examiner also examine Schedule C positions during due diligence examinations. With regards to Schedule C, the examiner usually want to know whether the paid return preparer obtained and maintained contemporaneous evidence of gross receipts and business deductions taken on the return by Self-Employed taxpayers filing their business activities using Schedule C attached to their Form 1040.
INTERVIEWER:Mlaah Singh, Tax Law Clerk
Interviewer Comment: Thank you for that detailed explanation. I hope listeners understand exactly what is expected of them when beginning this process. The greatest importance lies in obtaining contemporaneous factual knowledge and documentation on the taxpayers eligibility, keeping all this contemporaneous documentation in an organized business records manner, and finally, being prepared for IRS due diligence compliance investigations, if and when the IRS examiner comes knocking!
Question Number Three: What strategies can tax return preparers implement to proactively mitigate the risk of triggering an IRS due diligence investigation?
Interviewee: Coleman Jackson, Lawyer
ATTORNEY ANSWER – QUESTION 3
Well I can think of three strategies that paid tax preparers can proactively take to ensure their compliance with their due diligence obligations Under Internal Revenue Code Section 6695. Three step[ approach:
Step Number One: The paid tax return preparer should annually attend a comprehensive Individual Tax Return Update by a quality continual education provider to make sure they are current on their federal tax knowledge. And depending upon their tax practice, the paid preparer may also want to consider taking annual CPE on partnership taxation, corporate taxation and other areas of high incident in their individual practices.
Step Number Two: The paid tax return preparer should implement good prepare and implement good client intake policies, procedures and practices to make sure they obtain all relevant facts about their client’s eligibility to claim these tax positions that would likely trigger a flag for IRS investigators that could initiate a Paid Due Diligence Examination, Keep in mind that the preparer needs gather contemporaneous evidence of the taxpayer’s eligibility to take credits like the child tax credit, additional child tax credit, other dependent credit, earned income credit and head of household filing status. Tax preparers need to have actual knowledge of their clients eligibility to take these tax positions. So step two is a critical strategic step, and another critical strategy step is step three
Step Number Three: The paid tax preparer should establish and implement good record and file retention policies so that if the IRS examiner does exam them, they can readily show the agents that they have complied with Internal Revenue Code Section 6695 due diligence requirements.
Mlaah this is an excellent question. I have mentioned three of the most important strategic steps that I can think of right now that the paid preparer could consider. Bottom line: paid preparers must know the applicable tax law relevant to their tax practices, they must have actual contemporaneous knowledge of their customer’s eligibility to take these tax positions, and they must create and keep contemporaneous documentation of their client’s eligibility to take the tax positions for a minimum of three years after filing the return.
INTERVIEWER:Mlaah Singh, Tax Law Clerk
Interviewer Comment: It seems as though it is mostly important to keep for paid tax return preparers to keep current on federal tax law updates and make sure they contemporaneously gather the knowledge and records to support all the advice they give taxpayers and maintain good business records on every single taxpayer.
Question Number Four: How can paid tax return preparers effectively communicate and cooperate with the IRS during an investigation to achieve the best possible outcome?
Interviewee: Coleman Jackson, Lawyer
ATTORNEY ANSWER – QUESTION 3
■Thanks for this question. How can paid tax return preparers effectively communicate and cooperate with the IRS during an investigation to achieve the best possible outcome?
■Effective Communication requires the ability to listen. So the paid preparer read very carefully correspondence that the IRS may send them concerning opening an Internal Revenue Code Section 6695, Paid Preparer Due Diligence Examination;
■Effective Communication requires the ability to carry on a conversation. Remember conversations are two way. So the preparer should make sure that they understand what the IRS is saying to them. If there are language barriers, for example, if the taxpayer’s native language is other than English, they should request that a competent language translator be present in meetings with IRS examiners. I have even seen where cultural differences have hampered paid preparers understanding and ability to communicate and understand IRS examiners who have limited language and cultural sensitivities. The United States is a multicultural nation and sometimes; I have seen in paid preparer due diligence examinations, instances where multicultural differences and nuisances have hindered effective communications when that fact is ignored or misunderstood. Patience and tolerance are required for effective communications.
■Effective communication requires treating one another with dignity and respect. So the preparer should act professionally and treat the IRS examiner with dignity and respect. They are doing their job and they should not be treated with hostility and avoidance. The preparer should be fully candid and cooperative throughout the process, and
■Effective communication requires knowledge. Knowledge does not only derive from academic or educational learning but from life experiences as well. Therefore the paid preparer should hire a lawyer with experience in representing tax preparer’s in Internal Revenue Code Section 6695 investigations. This could greatly improve the effectiveness of communications between the paid preparer and the IRS due diligence examiner. This is because without experience in going through a paid preparer due diligence examination, the paid preparer may not appreciate the complexity and dangers, and the paid preparer may not fully understand the possible financial penalties and damage that could result, and finally, the paid preparer may not fully appreciate the damage that can occur to their reputation, their tax practice and the potential impacts on their customers who are likely to be audited by the IRS whenever the paid preparer is under IRS scrutiny for violations of Internal Revenue Code Section 6695, Paid Preparer Due Diligence Requirements and Penalties.
INTERVIEWER WRAP-UP: MlaahSingh, Tax Law Clerk
Attorney, thank you for sitting with me today in our second podcast on this very important topic: “Tax Return Preparer Due Diligence Requirements & IRS Paid Preparer Penalty Cases” I surely hope our audience will benefit from this Legal Thoughts series on tax preparer due diligence requirements and due diligence penalty cases. Attorney in this Episode you have clearly explained how regular, hardworking, innocent taxpayers can also suffer grave financial lost when they erroneously claim credits or take tax positions for which they are not entitled. Thanks Attorney for navigating us through this! Folks, stay tune for upcoming Legal Thoughts Podcasts dealing with international tax issues, federal tax issues, state and local tax issues, contracts litigation, business structuring, wills, trusts and estate legal matters and immigration law matters. We typically produce and publish Legal Thoughts every two weeks. So subscribe and follow our Legal Thoughts Podcast on Spotify, Apple Podcast, or Google Podcast. Hey check out our talks on the Corporate Transparency Act’s Beneficial Ownership Information Reporting Requirements that set to effect over 42 million small and medium sized business all over the United States. We have produced several podcast on this important business law topic.
Our audience can send us inquires at www.cjacksonlaw.com if they have questions or wish to comment on our podcasts in this series or any of our Legal Thoughts podcasts, blogs, or Law Watch Videos posted on our U-tube Channel. You can send an email directly to attorney at cj@cjacksonlaw.com and suggest other tax law, business law and immigration law topics that you want us to discuss in future Legal Thoughts Podcast. We are open to your ideas and suggestions for topics in tax law, business law and immigration law. What’s on your mind?
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Our listeners who want to hear more podcasts like this one please subscribe to our Legal Thoughts Podcast on Apple Podcast, Google Podcast, Spotify or wherever you listen to your podcast. Everybody take care! And come back in about two weeks, for more taxation, business structuring, contracts litigation and immigration Legal Thoughts from Coleman Jackson, P.C., located right here in Dallas, Texas at 6060 North Central Expressway, Suite 620, Dallas, Texas 75206.
■English callers: 214-599-0431 | Spanish callers: 214-599-0432 |Portuguese callers: 214-272-3100
ATTORNEY’S CLOSING REMARKS:
This is the end of “LEGAL THOUGHTS” for now
■By the way, another important topic our law firm has been talking about since last year is this one: All our small business owners must listen to our earlier podcasts on the Corporate Transparency Act’s Beneficial Ownership Information Reporting Requirements because the Initial BOI reports are due on or before January 1, 2025 for most small and medium sized businesses structured under any State Business Structuring Laws. Such as, Limited Liability Companies, Corporations and so forth. These initial BOI reports are required to be filed with the Financial Crimes Enforcement Network by January 1, 2025. Small Business Owners and those who substantially control them must educate themselves and comply with the CTA because the penalties are up to $500 per day and up to 2 years in federal prison upon conviction for willful failure to comply with this new federal law.
Until next time, take care.
If you want to see or hear more taxation, business structuring and contracts litigation and immigration LEGAL THOUGHTS from Coleman Jackson, P.C. Subscribe to our Legal Thoughts Podcast on Apple Podcast, Google Podcast, Spotify or wherever you listen to your podcast. Stay tuned! We are here in Dallas, Texas and want to inform, educate and encourage our communities on topics dealing with taxation, litigation and immigration. Until next time, take care
