10.1 Tax Practice Ethics and Preparer Responsibilities
Key Takeaways
- REG Area I (Ethics, Professional Responsibilities and Federal Tax Procedures) is weighted 10-20% of the REG section and tests Circular 230, preparer rules, and licensing duties.
- Treasury Circular 230 governs practice before the IRS and demands competence, diligence as to accuracy, conflict management, return of records, and reliable written advice.
- Taxpayer liability and preparer liability are separate: the same return can create taxpayer tax, interest, and penalties while independently exposing the CPA to IRC Sec. 6694/6695 preparer penalties.
- A preparer may rely on client information only when it appears correct and complete; inconsistencies, omissions, or implausible amounts trigger a duty to make reasonable inquiries.
- IRC Sec. 7216, the limited Sec. 7525 practitioner privilege, and the AICPA Code create overlapping confidentiality rules that are tested through consent and third-party-disclosure scenarios.
Why Ethics Is a REG Scoring Opportunity
The 2026 AICPA REG blueprint places Ethics, Professional Responsibilities and Federal Tax Procedures in Area I with a 10-20% weighting. REG itself is a four-hour section of 72 multiple-choice questions and 8 task-based simulations, scored 50% MCQ and 50% TBS, with a passing scaled score of 75. Area I is smaller than the tax areas, but it is dense and predictable: fact patterns are compact, so each correct ethics decision is efficient points. A candidate must decide whether a preparer may sign, whether a position needs disclosure, whether a communication is privileged, or whether a conflict blocks representation.
Circular 230 Conduct Duties
Treasury Department Circular 230 (31 C.F.R. Part 10) governs practice before the Internal Revenue Service for CPAs, attorneys, enrolled agents, and others. For REG, master the Subpart B conduct duties, not disciplinary trivia. A practitioner must: be competent (Sec. 10.35); exercise due diligence as to accuracy (Sec. 10.22); not unreasonably delay matters; promptly return client records on request even in a fee dispute (Sec. 10.28); manage conflicts of interest (Sec. 10.29); base written advice on reasonable factual and legal assumptions, not on audit-lottery odds (Sec. 10.37); and avoid disreputable conduct.
| Duty area | Exam signal | Required CPA response |
|---|---|---|
| Competence (10.35) | New issue outside the CPA's experience | Acquire competence, consult, or decline |
| Diligence (10.22) | Client facts inconsistent or implausible | Make reasonable inquiries; document |
| Conflict (10.29) | Two clients with adverse tax interests | Obtain informed written consent or withdraw |
| Written advice (10.37) | Client wants a penalty-protection memo | Rely on reasonable assumptions, not audit risk |
| Client records (10.28) | Client requests source documents back | Return promptly even amid a fee dispute |
A Sec. 10.29 conflict is waivable only with informed written consent from each affected client, retained for at least 36 months. Audit risk (the chance a return is examined) may never be a factor in advising a position.
Preparer Penalties: Sec. 6694 and 6695
A tax return preparer is anyone who prepares for compensation all or a substantial portion of a return or refund claim; this includes signing and nonsigning preparers. REG separates the taxpayer's exposure from the preparer's.
- IRC Sec. 6694(a) penalizes an unreasonable position. The position must meet the substantial authority standard if undisclosed (roughly a 40% chance of success), or merely reasonable basis (about 20%) if adequately disclosed on Form 8275. A tax shelter or reportable transaction requires the higher more likely than not standard (greater than 50%).
- IRC Sec. 6694(b) penalizes willful or reckless conduct and is far larger than 6694(a).
- IRC Sec. 6695 covers procedural failures: failure to sign, failure to furnish a PTIN (preparer tax identification number), failure to give the taxpayer a copy, failure to retain records, and failure to meet due-diligence requirements (Form 8867) for the earned income credit, child tax credit, American opportunity credit, and head-of-household status.
The blueprint states candidates are not tested on specific inflation-indexed dollar amounts. Learn the trigger instead: what conduct occurred, who committed it, and whether disclosure or reasonable cause and good faith changes the result. A 6694(a) penalty is waived if the position had reasonable cause and the preparer acted in good faith.
The Duty of Reasonable Inquiry
A CPA may rely on client information in good faith, but not blindly. If a client says "use last year's numbers" while documents show different facts, the CPA must inquire enough to confirm a supportable position. Substantiation matters most for deductions, credits, filing status, basis, and foreign-account reporting (FBAR/FinCEN Form 114). When a deduction appears to require records (e.g., travel, meals, charitable gifts over set thresholds), the preparer must confirm the client has them.
Worked scenario. A client reports $40,000 of consulting income but claims $38,000 of "office supplies." The implausible ratio is a red flag. The CPA must ask reasonable questions and obtain support. Disclosure does not cure invented facts — Form 8275 reduces penalty risk only when a genuine, factually supported position exists.
Confidentiality, Sec. 7216, and the Sec. 7525 Privilege
Three overlapping rules appear:
- AICPA Code of Professional Conduct — a member must keep client information confidential.
- IRC Sec. 7216 — criminal restriction on a preparer's disclosure or use of tax return information without the client's specific, signed consent; civil counterpart is Sec. 6713.
- IRC Sec. 7525 — a limited federally authorized tax practitioner privilege for tax advice. It does NOT apply to: criminal matters, written tax-shelter promotion, or state proceedings. It is narrower than the attorney-client privilege.
In any confidentiality question, identify who is asking, whether the client gave signed consent, and whether an exception (subpoena, peer review, Sec. 7216 carve-out) applies. A common trap pairs Sec. 7216 (a preparer's use/disclosure of return information) with a software vendor or marketing offer: using return data to pitch unrelated products requires separate, specific consent that states the purpose. Note that workpapers a CPA prepares are generally the CPA's property, while original client source documents must be returned on request under Sec. 10.28.
Exam Pattern
For each ethics fact pattern, ask four questions: (1) Who is the actor — taxpayer or preparer? (2) What duty or Code section applies? (3) What fact creates the red flag? (4) What action is required before signing, advising, or representing?
A CPA is preparing an individual return. The client claims a large deduction but provides no records, and the explanation conflicts with bank statements already given to the CPA. What should the CPA do before signing the return?
Under IRC Sec. 6694(a), what standard must an undisclosed, non-tax-shelter return position generally meet to avoid the unreasonable-position preparer penalty?