CPA Exam — REG (Regulation)Ethics, Professional Responsibilities, and Federal Tax ProceduresMedium
A CPA is preparing a federal income tax return for a client. During the preparation, the CPA identifies a potential tax shelter transaction taken by the client that lacks economic substance and appears to be designed solely for tax avoidance. The CPA determines that there is no reasonable basis for the position. Under AICPA Statements on Standards for Tax Services (SSTS), what is the CPA's appropriate action?
- AAdvise the client against taking the position and do not prepare the return with that position included.
- BPrepare the return as instructed by the client, but include a disclosure statement explaining the aggressive nature of the position.
- CReport the client and the transaction to the IRS immediately due to its potential for tax avoidance.
- DPrepare the return with the position, but only if the client agrees to indemnify the CPA against any penalties.
Show answer & explanationAnswer & explanation
Correct answer: A. Advise the client against taking the position and do not prepare the return with that position included.
Under SSTS No. 1, a CPA should not recommend a tax return position or prepare or sign a tax return that takes a position unless the CPA has a good faith belief that the position has at least a realistic possibility of being sustained on its merits. If there is no reasonable basis, the CPA cannot include it.
Why the other options are wrong
- B. A disclosure does not legitimize a position that lacks a reasonable basis; the CPA should not include it.
- C. Reporting to the IRS is generally prohibited by client confidentiality rules, unless legally required or client consent is given, which is not the case here.
- D. Indemnification agreements do not negate the CPA's professional responsibility to adhere to tax standards.
SSTS No. 1 Tax Return Positions
SSTS No. 1 requires a CPA to have a good faith belief that a tax return position has at least a 'realistic possibility of being sustained on its merits' to recommend it or prepare a return including it. If not, the CPA should advise against it.
- Minimum standard is 'realistic possibility' (1-in-3 chance).
- If standard not met, CPA should not prepare return with that position.
- Disclosure does not cure a lack of realistic possibility.
- Applies to all tax return positions, not just tax shelters.
Memory trick: No solid ground? Then don't write it down!