A CPA prepares a federal income tax return for a client. The CPA, in good faith, relies on information provided by the client, which the CPA believes to be accurate. Later, it is discovered that the client provided fraudulent information, leading to an understatement of tax. Assuming the CPA had no reason to doubt the information and conducted no independent verification beyond what is typical for tax preparation, what is the CPA's liability for preparer penalties under IRC Sec. 6694?
- AThe CPA is liable for preparer penalties because the fraudulent information resulted in an understatement of tax.
- BThe CPA is not liable for preparer penalties, as they were not negligent and relied on client information in good faith.
- CThe CPA is liable for penalties because they failed to verify the client's information independently.
- DThe CPA is liable for penalties, but only if the IRS can prove the CPA had actual knowledge of the fraud.
Show answer & explanationAnswer & explanation
Correct answer: B. The CPA is not liable for preparer penalties, as they were not negligent and relied on client information in good faith.
IRC Sec. 6694 generally imposes penalties on tax preparers for understatements due to unreasonable positions. However, a preparer is not required to independently verify information provided by a client if the preparer reasonably believes the information is correct. Good faith reliance on client-provided information, without reason to doubt it, generally shields the preparer from penalties.
Why the other options are wrong
- A. The preparer's liability depends on their conduct, not solely on the outcome of the client's fraud.
- C. Preparers are generally not required to audit or independently verify client information unless there are red flags.
- D. While actual knowledge would lead to penalties, lack of actual knowledge, combined with good faith reliance, is a defense.
Preparer Reliance on Client Information
A tax preparer may generally rely in good faith on client-provided information without independent verification, unless there is reason to doubt its accuracy.
- Good faith reliance is a defense against preparer penalties.
- No requirement to audit or verify client data independently.
- Must make reasonable inquiries if information appears incorrect, inconsistent, or incomplete.
- This applies to IRC Sec. 6694 penalties for unreasonable positions.
Memory trick: Good faith reliance, avoids penalty appliance.