2.2 Diligence, Written Advice, Fees, and Records

2.2 Diligence, Written Advice, Fees, and Records

/practice/cpa-regPractice questions with detailed explanations

Due diligence (§10.22) and reliance on client information (§10.34(d))

§10.22(a) requires a practitioner to exercise due diligence (1) in preparing or assisting in the preparation of, approving, and filing returns, documents, affidavits, and other papers relating to IRS matters; (2) in determining the correctness of oral or written representations the practitioner makes to the Department of the Treasury; and (3) in determining the correctness of oral or written representations the practitioner makes to clients about any matter administered by the IRS. Diligence is not limited to the Form 1040 the CPA signs. A careless oral statement to a revenue agent and a careless email to a client are both §10.22 events.

§10.22(b) creates a presumption: except as provided in §§10.34 and 10.37, a practitioner is presumed to have exercised due diligence if the practitioner relies on another person’s work product and used reasonable care in engaging, supervising, training, and evaluating that person, taking proper account of the relationship. Staff review is therefore part of the CPA’s own diligence, not a way to outsource it.

§10.34(d) is the companion reliance rule for facts. A practitioner advising a position, preparing a paper, or signing a return as a preparer generally may rely in good faith without verification upon information furnished by the client. Two limits, both heavily tested, sit on that sentence. The practitioner may not ignore the implications of information furnished to, or actually known by, the practitioner, and must make reasonable inquiries if the information as furnished appears incorrect, inconsistent with an important fact or another factual assumption, or incomplete. A client’s verbal claim of a $90,000 cash charitable contribution, unaccompanied by a contemporaneous written acknowledgment and inconsistent with a bank-statement pattern showing no such outflow, is a red flag. Accepting the number because “the client signed the organizer” is not good-faith reliance.

§10.35 adds competence: the practitioner must possess the knowledge, skill, thoroughness, and preparation necessary for the matter. Competence can be acquired for the engagement by studying the relevant law or consulting experts. Taking a first-time partnership basis engagement without either step is a competence failure even if the CPA means well.

Knowledge of a client’s omission (§10.21)

§10.21 is short and easy to misread. A practitioner who, having been retained with respect to a matter administered by the IRS, knows that the client has not complied with the revenue laws, or has made an error in or omission from any return, document, affidavit, or other paper the client submitted or executed under the revenue laws, must advise the client promptly of the fact of the noncompliance, error, or omission. The practitioner must also advise the client of the consequences under the Code and regulations.

What §10.21 does not say is as important as what it says. It does not, by itself, require the practitioner to disclose the client’s error to the IRS. It does not require the practitioner to amend the return without client authorization. It does not create a whistleblower duty. The next professional step is counseling: explain the error, explain failure-to-file, failure-to-pay, accuracy-related, and (if facts warrant) fraud consequences, and explain how an amended return or other corrective filing would operate. If the client refuses to correct a known understatement and asks the CPA to continue on the same facts into next year, the CPA must not sign a new return that the CPA knows understates liability; withdrawal may be required. How an examination then unfolds is a tax-procedure issue covered in /study-guides/cpa-reg/tax-procedure/audits-appeals-judicial.

AICPA members have a parallel counseling duty under the Statements on Standards for Tax Services; those standards bind members in tax practice in addition to Circular 230, but they do not replace §10.21.

Return of client records (§10.28) and conflicts (§10.29)

§10.28(a) requires a practitioner, at the client’s request, to promptly return any and all records of the client that are necessary for the client to comply with federal tax obligations. The practitioner may keep copies. A dispute over fees generally does not relieve this duty. If applicable state law permits a retaining lien in a fee dispute, the practitioner need only return those records that must be attached to the taxpayer’s return, but must still give the client reasonable access to review and copy additional client records the practitioner retains that are necessary for federal tax compliance.

Records of the client (§10.28(b)) include materials the client or a third party provided that preexisted the engagement, materials the client or a third party prepared and provided for the representation, and a return, claim, or other document the practitioner prepared and presented to the client in a prior representation if that document is necessary for current compliance. The term does not include the practitioner’s own work product held pending payment, except as the regulation otherwise requires.

§10.29 forbids representation if (1) the representation of one client will be directly adverse to another client, or (2) there is a significant risk that the representation of one or more clients will be materially limited by responsibilities to another client, a former client, or a third person, or by a personal interest of the practitioner. A practitioner may proceed despite a conflict only if the practitioner reasonably believes competent and diligent representation can be provided to each affected client, the representation is not prohibited by law, and each affected client gives informed consent, confirmed in writing at the time the existence of the conflict is known by the practitioner, and in no event later than 30 days after the informed consent. Written consents must be retained at least 36 months from the conclusion of the representation of the affected clients and produced to the IRS on request. A classic REG fact pattern is a CPA asked to represent both spouses in a jointly filed year after they separate and take inconsistent positions on who is entitled to a refund: that is a §10.29 problem before it is a tax-computation problem.

Solicitation (§10.30) and contingent fees (§10.27) — the original-return trap

§10.30 prohibits public communication or private solicitation containing a false, fraudulent, or coercive statement or claim, or a misleading or deceptive statement or claim. Enrolled agents, ERPAs, and registered tax return preparers may not use the term “certified” or imply an employer-employee relationship with the IRS. Lawful solicitations must be identified as such and, if applicable, must identify the source of the information used to choose the recipient. A practitioner who publishes a fee schedule may charge no more than the published rates for at least 30 calendar days after the last date the schedule was published. Direct-mail and e-commerce copies must be retained at least 36 months.

§10.27(a) forbids an unconscionable fee in connection with any matter before the IRS. §10.27(b)(1) then states the contingent-fee rule REG hammers: except as provided in paragraphs (b)(2), (b)(3), and (b)(4), a practitioner may not charge a contingent fee for services rendered in connection with any matter before the IRS.

A contingent fee (§10.27(c)(1)) is any fee based, in whole or in part, on whether a position taken on a tax return or other filing avoids IRS challenge or is sustained by the IRS or in litigation. The definition expressly includes a fee based on a percentage of the refund reported on a return, a percentage of taxes saved, a fee that otherwise depends on the specific result attained, and a fee arrangement in which the practitioner will reimburse all or part of the client’s fee if a position is challenged or not sustained (indemnity, guarantee, or rescission).

The three exceptions, taken from the current Circular 230 text rather than from lore, are:

1. §10.27(b)(2): A contingent fee may be charged for services in connection with the IRS’s examination of, or challenge to, (i) an original tax return, or (ii) an amended return or claim for refund or credit filed within 120 days of the taxpayer receiving written notice of the examination of, or a written challenge to, the original return.
2. §10.27(b)(3): A contingent fee may be charged for a claim for credit or refund filed solely in connection with the determination of statutory interest or penalties assessed by the IRS. This is not a general license to take ordinary refund claims on contingency.
3. §10.27(b)(4): A contingent fee may be charged for services in connection with any judicial proceeding arising under the Internal Revenue Code.

Exam trap: charging 20 percent of the refund shown on an original Form 1040, or “no refund, no fee” for original-return preparation, is a contingent fee for a matter before the IRS and is not within (b)(2)–(b)(4). “Matter before the Internal Revenue Service” in §10.27(c)(2) expressly includes preparing or filing returns or claims for refund. Candidates who remember only “contingent fees are allowed for refund claims” fail this item. The exception is narrower: IRS examination or challenge, a 120-day window for a related amended return, statutory interest or penalty determinations, and Tax Court or other IRC judicial proceedings.

Original return preparation  -->  contingent fee PROHIBITED
IRS exam / written challenge -->  contingent fee permitted (b)(2)
Interest/penalty-only claim  -->  contingent fee permitted (b)(3)
IRC judicial proceeding      -->  contingent fee permitted (b)(4)

Standards for returns (§10.34) and written advice (§10.37)

§10.34(a) provides that a practitioner may not willfully, recklessly, or through gross incompetence sign a return or claim, or advise a position, that lacks a reasonable basis, that is an unreasonable position under IRC §6694(a)(2), or that is a willful attempt to understate tax or a reckless or intentional disregard of rules or regulations under §6694(b)(2). A pattern of conduct is a factor in determining willfulness, recklessness, or gross incompetence. Documents submitted to the IRS must not be frivolous, must not be filed to delay administration of the tax laws, and must not demonstrate intentional disregard of a rule or regulation unless the practitioner also advises a good-faith challenge.

§10.34(c) requires the practitioner to inform the client of any penalties reasonably likely to apply to a position the practitioner advised or a return the practitioner prepared or signed, and of any opportunity to avoid those penalties by disclosure, including the requirements of adequate disclosure. That counseling duty applies even if the practitioner would not personally be subject to a Code penalty on the paper.

§10.37 governs written advice (including email) concerning one or more federal tax matters. Government submissions on general policy and ordinary CPE presentations are generally outside the section; marketing presentations are not. The practitioner must:

• base the advice on reasonable factual and legal assumptions (including assumptions as to future events);
• reasonably consider all relevant facts and circumstances the practitioner knows or reasonably should know;
• use reasonable efforts to identify and ascertain the relevant facts;
• not rely on representations, statements, findings, or agreements if reliance would be unreasonable;
• relate applicable law and authorities to facts; and
• not, in evaluating a federal tax matter, take into account the possibility that a tax return will not be audited or that a matter will not be raised on audit.

Reliance on another person’s advice is allowed only if the advice was reasonable and the reliance is in good faith considering all facts and circumstances. Reliance is not reasonable if the practitioner knows or reasonably should know that the opinion should not be relied on, that the other person is not competent or lacks necessary qualifications, or that the other person has an unresolved conflict. OPR reviews written advice under a reasonable practitioner standard, considering all facts and circumstances, including the scope of the engagement and the type of advice sought. When the practitioner knows or has reason to know that an opinion will be used or referred to by someone else in promoting a partnership or other arrangement a principal purpose of which is tax avoidance or evasion, the review emphasizes additional facts and circumstances.

Taken together, §§10.22, 10.34, and 10.37 describe one professional posture: verify what looks wrong, counsel the client about penalty exposure, put advice in writing only on reasonable assumptions, and never price or reason from the chance that the IRS will not look.