Tax Pros, Leave Your Bad Habits Behind You. Part 3: Competence – You Need It. If You Don’t Have It – Get It.

I took three of my kids ice skating in Maggie Daley Park last month. It is hard to find fun things to do together during the pandemic, and I never had the stomach to brave the lines during “before times.” One of the many silver linings I’ve embraced during this otherwise incredibly difficult time is being able to go to fun things like ice skating in downtown Chicago without being overly crowded. Social distancing actually makes it easier to go ice skating. As we were heading out the door, my husband looked at me incredulously. “Are you going to ice skate?” he had the nerve to ask me with an eyebrow raised. I took ice skating in high school gym class. I fancied myself, in my admittedly somewhat embellished memory, as perhaps a step or three below Katerina Witt, a skating hero of mine. Of course I was going to ice skate, I felt sure it was just like riding a bike and I’d be doing figure eights and skating backward, just as I was in the mid-90’s. I’d like to say that my pride was the part of me that was the most bruised that day, but I would be lying. I fell three times in twenty minutes, and the third time I fell so hard I slid into the wall with my head. (And while I had insisted my kids wear helmets, I stupidly didn’t put one on myself). I faced reality and got off the ice, my kids zooming by me and waving from the skating ribbon. What does this have to do with tax, you ask? Well, even though I was (admittedly) delusional about my skating ability, tax professionals have an affirmative ethical obligation to ask themselves before “getting on the ice,” am I up to this tax engagement? And if the answer is no, unlike my ill-fated foray onto the skating ribbon, we have an ethical obligation to turn it down.

Section 10.35 of Circular 230 (see my prior column on how important it is to read the whole document if you are a tax professional) is short and to the point:

(a) A practitioner must possess the necessary competence to engage in practice before the Internal Revenue Service. Competent practice requires the appropriate level of knowledge, skill, thoroughness, and preparation necessary for the matter for which the practitioner is engaged. A practitioner may become competent for the matter for which the practitioner has been engaged through various methods, such as consulting with experts in the relevant area or studying the relevant law.

In plain English, this means that tax practitioners must either be competent to handle a particular matter, or become competent to handle a matter, either through consulting with those who are competent or studying the area. Seems obvious, right? Wrong. In my career as a tax litigator, unless a case is a dispute over something that is guaranteed to be a dispute, such as a listed transaction, 90% of my work results from a practitioner who wasn’t competent to handle something, but tried to do it anyway.

For example, I have had several cases that resulted from a return preparer who didn’t have expertise in reporting for foreign financial accounts or assets, but prepared returns for clients who had foreign financial accounts or assets anyway. Those preparers who forged ahead often had long-standing relationships with clients and instead of saying to the client, “I’m not an expert in reporting foreign accounts, I think you need to get some advice from someone who is,” they went ahead and either tried to figure out the rules themselves or just assumed the rules are the same for reporting foreign income, gifts, and assets as they are for domestic. Well, not only are the reporting rules not the same, but the penalty rules are not either. In fact, the penalties applicable to foreign income, gifts, inheritence, and assets are incredibly costly and often taxpayers do not have the opportunity to contest those penalties or assessments in Tax Court prior to assessment or collection.

For instance, take gift tax. Most tax professionals can tell you the general rule in their sleep: gifts are reportable by the donor, and gift tax, if applicable at all, is payable by the donor. Estate tax is payable by the estate, not the beneficiaries. All of this is true unless the gift or inheritance we are talking about is a gift or inheritance paid to a United States person from a non-United States person. Any U.S person who receives more than $100,000 from a non-US person or a foreign estate must file IRS Form 3520 and report that gift or inheritance to the IRS. There isn’t any tax due, but the fact of the gift or inheritance has to be reported.

You might be thinking, well, if there isn’t any tax due, then what’s the harm from giving the wrong advice? The harm is in the Information Return Reporting penalty, which is the greater of $10,000 or up to 35% of the amount of the gift. If Aunt Katherine from Ireland, who has never been to the United States and is not a United States person, leaves you $200,000, you must report that to the IRS, and even though no tax is due, if you fail to file IRS Form 3520 and report the gift or inheritance, you could end up owing the IRS 35% of that money for the failure to file the form.

All of this goes to show that tax professionals need to take the Circular 230 competence requirement seriously, and either be honest with clients when they don’t have the necessary competence, work with someone who does, or take enough continuing education to become competent. And if a tax professional is taking the “become comptent” route, the obligation under section 10.33(4) to act fairly and with integrity in practice before the IRS requires, at a minimum, not charging the client to become comptent and letting the client know that the practitioner does not already possess the skills and knowledge necessary to handle the matter, but is working to aquire it.

After all, dispensing tax advice is nothing like riding a bike, and we owe our clients the chance to choose not to go sliding head-first into the wall with us.