Avoiding fallout from aggressive tax strategies

June 7, 2021

By Deborah K. Rood, CPA 

BOSS. Son of boss. Syndicated conservation easement transactions. Microcaptive insurance companies. What do these tax planning strategies have in common? They all appeared "too good to be true," and the IRS, upon examination of related tax returns, agreed. Taxpayers were assessed substantial penalties, and CPAs were penalized as well. CPAs acting as promoters of syndicated conservation easements pleaded guilty to criminal conspiracy charges, and a Big Four firm admitted to criminal wrongdoing, paying $456 million in fines, restitution, and penalties to defer prosecution related to son-of-boss strategies.

While the risk of creating, promoting, and selling aggressive tax strategies is understood by most CPAs, significant risk remains for those CPAs who "just make introductions," provide tax consulting services, or prepare returns that reflect too-good-to-be-true tax strategies. Consider these scenarios:

After attending a law firm seminar about a new tax planning strategy, a CPA identifies clients for whom the strategy may apply, provides them an overview, and facilitates an introduction to the law firm. Several clients subsequently implement the strategy.

Alternatively, other clients may identify and implement a tax planning strategy on their own without the CPA's involvement.

Irrespective of the scenario, the strategy is ultimately reflected on the client's tax return prepared by the CPA. If a taxing authority subsequently disputes the merits of the tax strategy, regardless of the extent of the CPA's involvement, the client may bring a claim against the CPA for penalties, interest, loss of the anticipated tax benefit, and other mitigation expenses.

CHARACTERISTICS OF TOO-GOOD-TO-BE-TRUE TAX PLANNING STRATEGIES

If a planning strategy has one or more of the following characteristics, it may be too good to be true.

  • A promoter is involved. Promoters often receive commissions, which may incentivize them to operate in their own interest, not the client's or CPA's.
  • A signed confidentiality agreement is required to learn about the strategy. Confidentiality agreements create an aura of exclusivity, but they may also be an attempt to prevent the IRS from getting wind of a potential strategy.
  • The strategy appears to run afoul of one or more judicial doctrines. Federal court decisions have established various judicial tax doctrines. If a transaction does not withstand scrutiny under one or more of these doctrines, it is less likely to be upheld upon examination.
    • The substance-over-form doctrine allows the IRS to ignore the legal form of a transaction and examine whether its substance results in tax avoidance.
    • The step-transaction doctrine treats a series of separate steps as a single transaction to determine the underlying intent.
    • The business-purpose doctrine invalidates a transaction if it appears that it has no substantial business purpose other than to obtain tax benefits.
    • The sham-transaction doctrine identifies transactions where the economic activities purported to give rise to the tax benefits do not occur.
    • The economic substance doctrine invalidates a transaction if the transaction lacks economic substance independent of the tax considerations.
  • Professionals associated with the strategy are paid a higher-than-customary fee. While the professionals may have invested considerable time and resources in developing the tax planning strategy, fees should be similar to those for other strategies.
  • The strategy is overly complex. Is the "loophole" the strategy is trying to fit through so narrow that a complex structure must be created to meet the exception? If many attorneys, CPAs, and other advisers are involved, maybe.
  • Contracts with the promoter attempt to limit damages. Beware of provisions purporting to limit recoverable damages if the transaction fails under scrutiny and have all such contracts reviewed by legal counsel prior to execution. Check for disciplinary actions or complaints against the promoter.

MANAGING THE RISK

The best way for a CPA to mitigate risk is to decline to provide services to clients who have invested in too-good-to-be-true planning strategies. However, this approach is not always practical. Instead, proceed with caution and consider the following practices.

Referrals to other professionals

Referring any client to a professional to assist with a too-good-to-be-true tax strategy is risky, but for a client who lacks financial sophistication, it is imprudent. Unsophisticated clients may be quick to blame the referring CPA, regardless of the CPA's risk management practices.

Financially sophisticated clients should understand and acknowledge the risk that a taxing authority may challenge and overturn the strategy and have the financial wherewithal to pay if this occurs. If a referral is made, follow the protocols outlined in the article "Professional Liability Spotlight: Unintended Consequences of Professional Referrals," JofA, Nov. 2020, and consider adding a recommendation that the client also engage a tax attorney to evaluate the strategy.

Consulting engagements

CPAs are often asked for off-the-cuff advice, especially related to tax savings opportunities. Avoid the temptation to respond. Such limited advice is fraught with professional liability risk, especially when related to a high-risk tax strategy. Instead, offer to perform a separate engagement to research the strategy and summarize its merits in a tax memorandum for the client.

Obtain a separate engagement letter for this service, and work with the client to define the specific scope of the services. In addition, include limitation-of-liability and limitation-of-damages risk allocation provisions, where permissible.

The deliverable should be a written memorandum to the client, summarizing the strategy's potential benefits and risks, and level of authority as discussed in AICPA Statements on Standards for Tax Services (SSTS) No. 1, Tax Return Positions.

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