CPA Exam — REG (Regulation)Ethics, Professional Responsibilities, and Federal Tax ProceduresEasy
A tax preparer is engaged by a client to prepare their federal income tax return. The client provides the preparer with a detailed spreadsheet of expenses, including several large, undocumented cash expenditures for business meals. The preparer questions the client, who states, "Those were legitimate business expenses, I just don't have the receipts anymore." What is the preparer's most appropriate course of action under Circular 230?
- AAdvise the client that documentation is required for these expenses and that they cannot be included without it.
- BExclude the expenses but inform the client that they can amend the return later if documentation is found.
- CInclude the expenses on the return as provided by the client, relying on the client's assertion.
- DInclude the expenses, but add a disclosure statement to the return indicating a lack of documentation.
Show answer & explanationAnswer & explanation
Correct answer: A. Advise the client that documentation is required for these expenses and that they cannot be included without it.
Circular 230 requires practitioners to exercise due diligence in preparing tax returns. This includes making reasonable inquiries when information appears incorrect, incomplete, or inconsistent. Undocumented cash expenditures require further substantiation.
Why the other options are wrong
- B. While the client could amend later, the preparer should not prepare a return with known unsubstantiated deductions in the first place.
- C. Relying solely on a client's assertion without further inquiry for undocumented expenses violates due diligence requirements.
- D. A disclosure statement does not remedy the lack of substantiation for expenses that require it, and the preparer should not knowingly include unsubstantiated expenses.
Circular 230 Due Diligence for Information
Tax practitioners must exercise due diligence in preparing returns, including making reasonable inquiries when client-provided information appears questionable or incomplete.
- Do not ignore implications of information furnished.
- Make reasonable inquiries if information appears incorrect or incomplete.
- Do not verify every item, but question red flags.
Memory trick: Diligent preparers 'Question Red Flags' to ensure accuracy.