Ethical Dilemma

  • Thread starter Phoebe Roberts, EA
  • Start date

P

Phoebe Roberts, EA

We have a situation involving 3 clients.

A, a married individual, had a successful sole
proprietorship for many years. She incorporated it as a
C-corporation (C) in 2000. B, a single individual for the
years in question, became a 50% owner in C immediately after
C was incorporated. A, B and C became our clients in 2001.

B called us yesterday to say that she was leaving C
(abandoning her stock, quitting her job, taking her clients
and going home). A is aware of it and is unhappy. B's
question for us was: What are the tax consequences of my
disposition of my stock in C?

B's version of the story is that she purchased 50% of A's
shares in C immediately after incorporation (in 2000) for
$75,000. At A's request, she paid for her shares not with
one large check to A, but with smaller checks to A and A's
relatives, who then gave cash or stuff to A. B's
recollection is that A told her that A would get a better
tax answer that way.

B filed no gift tax return, and had no donative intent. A's
2000 income tax return (prepared by her spouse; we have a
copy along with an IRS notice regarding a math error for
that year which is consistent with the return we have) does
not report a sale of C stock. C's books do not reflect a
sale of C stock, other than the original issue of stock to
A.

We haven't asked A what her version of the transaction is;
however, B's version is plausible to us based on our other
experiences with A.

My questions:
1) Without making further attempts to verify B's story, can
we (legally / ethically) accept that her basis in her C
stock is $75,000?
2) Can we continue to prepare returns for A, B and C without
creating a conflict of interest, assuming that everyone
wants that to happen? (B has specifically stated that she
wants to continue as our client. A and C have combined
billings 10 times that of B, and have been excellent
referral sources. If forced to choose, we'd keep B and fire
A and C.)
3) Are we obligated to inform A that she is obligated to
amend her 2000 tax return? If we had learned of the
transaction from an unrelated party, I think we would be,
but B has a vested interest in giving A a bad tax answer.
4) Should we, and if so, how can we verify B's story and
determine whether A filed an incomplete return without
violating B's privacy rights? Our privacy policy says
(among other things) "If you engage in tax-related
transactions with another of our clients, we are required to
report those transactions consistently. For example, if
their records show they made taxable payments to you, we are
required to report those payments on your return. However,
we will not discuss your tax return with them."
5) Should we just fire them all, because we know too much?

Any thoughts (or commiserations) appreciated.

Phoebe :)
 
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E

Ed Zollars, CPA

We haven't asked A what her version of the transaction is;
however, B's version is plausible to us based on our other
experiences with A.
That last statement bothers me--if B's statement is
plausible based upon your experiences with A, it suggests
you have reason to believe A is not honest. That suggests
that there should be an issue retaining A as a client
regardless of this particular issue. A client that can't be
trusted will turn on you in an instant if cornered.
My questions:
1) Without making further attempts to verify B's story, can
we (legally / ethically) accept that her basis in her C
stock is $75,000?
I would say yes, since the only evidence you seem to have
that B isn't telling the truth is a return that failed to
report the sale. That return was prepared by someone whom
you've already told us would have no problem not reporting
the sale.
2) Can we continue to prepare returns for A, B and C without
creating a conflict of interest, assuming that everyone
wants that to happen? (B has specifically stated that she
wants to continue as our client. A and C have combined
billings 10 times that of B, and have been excellent
referral sources. If forced to choose, we'd keep B and fire
A and C.)
Can you? Well, yes, I think so, although you would have
disclose to both parties the potential conflict that will
exist by continuing to represent both clients per Circular
230.

However, if you truly believe that A failed to report a sale
of stock, fully aware that he/she was doing something wrong,
that should impact your decision to retain the client.

The fact that the client pays you significant fees actually
makes the client even *more* of a risk, and one you should
be more apt to dismiss, not less. That is, this client can
(and probably will) attempt to make use of the fact that you
won't consider dismissing her to force you to accept taking
positions you wouldn't otherwise take. And then, as I note,
if the IRS examines her, she'll be the first to claim you
told her it was OK to do whatever it is that she is doing.

That is, it didn't appear to be much of a defense for David
Duncan to claim that it was "OK" for him to continue with
Enron as a client simply because they paid such high fees to
AA. In fact, it tended to have just the opposite effect on
the perception of his (and AA's) culpability in the
situation.
3) Are we obligated to inform A that she is obligated to
amend her 2000 tax return? If we had learned of the
transaction from an unrelated party, I think we would be,
but B has a vested interest in giving A a bad tax answer.
I don't believe you can tell A without B's consent, since
that would be releasing confidential client information
obtained in the preparation of a tax return, a violation of
federal law (it's actually a misdemeanor as I recall). Even
if you don't directly say B told you, it's going to be
pretty clear where the story had to come from.
4) Should we, and if so, how can we verify B's story and
determine whether A filed an incomplete return without
violating B's privacy rights? Our privacy policy says
(among other things) "If you engage in tax-related
transactions with another of our clients, we are required to
report those transactions consistently. For example, if
their records show they made taxable payments to you, we are
required to report those payments on your return. However,
we will not discuss your tax return with them."
I'm not sure I agree with that statement being in your
policy, since it creates the very issue you have here--you
are now obligated to verify B's position and A can claim
that if you fail to do so and A is examined on the matter,
you failed to perform according to your agreement. That is,
you've indirectly told A that you would inform A if another
of your client's indicated that A has unreported income.

So now if A is examined and penalized for failing to report
that income, you may be liable for any penalties and
interest, as well as paying for the representation on the
audit, under the theory that had A been told, then A would
have amended the return, and avoided the audit and
penalties. However, if you *tell* A then you are making an
unauthorized disclosure of information B gave you.

You also have a catch-22 problem here--if A's return is
correct and there truly was no payment (B did not pay A),
then perhaps B is the return that needs to be modified,
either to report income from being issued stock as an
employee or to reduce B's basis.

So which taxpayer do you force to be consistent with the
other?
5) Should we just fire them all, because we know too much?
At this point, given your policy, I would suggest firing
them all may be your only out unless B were to both prove
the basis *and* grant you permission to disclose this
information to A. At that point, you would need to inform A
that the prior return is in error, how to amend it, and the
potential problems if the return is not amended.

You are not required to prepare an amended return for A
unless A engages you to do so. However, you likely should
consider a refusal by A to amend the return in determining
if it makes sense to continue with A as a client.
 
H

Harlan Lunsford

We have a situation involving 3 clients.

A, a married individual, had a successful sole
proprietorship for many years. She incorporated it as a
C-corporation (C) in 2000. B, a single individual for the
years in question, became a 50% owner in C immediately after
C was incorporated. A, B and C became our clients in 2001.

B called us yesterday to say that she was leaving C
(abandoning her stock, quitting her job, taking her clients
and going home). A is aware of it and is unhappy. B's
question for us was: What are the tax consequences of my
disposition of my stock in C?

B's version of the story is that she purchased 50% of A's
shares in C immediately after incorporation (in 2000) for
$75,000. At A's request, she paid for her shares not with
one large check to A, but with smaller checks to A and A's
relatives, who then gave cash or stuff to A. B's
recollection is that A told her that A would get a better
tax answer that way.

B filed no gift tax return, and had no donative intent. A's
2000 income tax return (prepared by her spouse; we have a
copy along with an IRS notice regarding a math error for
that year which is consistent with the return we have) does
not report a sale of C stock. C's books do not reflect a
sale of C stock, other than the original issue of stock to
A.

We haven't asked A what her version of the transaction is;
however, B's version is plausible to us based on our other
experiences with A.

My questions:
1) Without making further attempts to verify B's story, can
we (legally / ethically) accept that her basis in her C
stock is $75,000?
2) Can we continue to prepare returns for A, B and C without
creating a conflict of interest, assuming that everyone
wants that to happen? (B has specifically stated that she
wants to continue as our client. A and C have combined
billings 10 times that of B, and have been excellent
referral sources. If forced to choose, we'd keep B and fire
A and C.)
3) Are we obligated to inform A that she is obligated to
amend her 2000 tax return? If we had learned of the
transaction from an unrelated party, I think we would be,
but B has a vested interest in giving A a bad tax answer.
4) Should we, and if so, how can we verify B's story and
determine whether A filed an incomplete return without
violating B's privacy rights? Our privacy policy says
(among other things) "If you engage in tax-related
transactions with another of our clients, we are required to
report those transactions consistently. For example, if
their records show they made taxable payments to you, we are
required to report those payments on your return. However,
we will not discuss your tax return with them."
5) Should we just fire them all, because we know too much?

Any thoughts (or commiserations) appreciated.
First I'm tempted to say, "Don't you Take no UGly clients!"

But seriously, the devil is in the details. I see no
evidence that B bought any stock atall, since you say only
one issue of stock is recorded in the books, i.e. original
issue to A. Don't matter that B "gave" all this money to
A's relatives, friends or acquaintances.

So then, I would be able to retain A and C as clients, but
show B the door.

But also would advise A to see a lawyer, since B might have
a claim against her for the 75000$.

And you might want to go with her to see the lawyer.

Cheer$,
HL, EA n LA
 
M

MTW

Any thoughts (or commiserations) appreciated.
Quick first impression: Is B ~really~ a shareholder? Does
she have a stock certificate or other records to prove it?

I'd be tempted to fire them all, but I'll "stew" on that
further. <g>

MTW
 
W

William Brenner

I am not a tax professional. But, as a (retired) business
executive of high ethical standards, I believe I am
qualified to comment on your problem.

And, indeed, you might have a serious problem should you
continue to have any relationship with A, B or C. Unless I
am missing something, B's story plus A's tax return indicate
that they colluded to allow A to evade taxes. (I will leave
it to the pros as to whether you have any obligation to
report this.)

I would not outright "fire" them; but would sorrowfully tell
both parties that their separation causes you to have a
conflict of interest and that you cannot bring yourself to
choose between them. Say no more! Especially do not mention
to either the real problem caused by B's allegation. Should
their actions lead to legal procedures or IRS involvement,
you can then testify truthfully with a clear conscience and
without jeopardizing yourself.

Bill
 
S

Stuart Bronstein

B's version of the story is that she purchased 50% of A's
shares in C immediately after incorporation (in 2000) for
$75,000. At A's request, she paid for her shares not with
one large check to A, but with smaller checks to A and A's
relatives, who then gave cash or stuff to A. B's
recollection is that A told her that A would get a better
tax answer that way.

My questions:
1) Without making further attempts to verify B's story, can
we (legally / ethically) accept that her basis in her C
stock is $75,000?
Can she show that she really made payments equalling that
amount? Even if made to A's relatives, if done at the
request of A, it seems to me that her claimed basis is
justified.
2) Can we continue to prepare returns for A, B and C without
creating a conflict of interest, assuming that everyone
wants that to happen? (B has specifically stated that she
wants to continue as our client. A and C have combined
billings 10 times that of B, and have been excellent
referral sources. If forced to choose, we'd keep B and fire
A and C.)
I'd get it in writing from all of them, acknowledging that
there could be a conflict of interest, but that they all
want you to do their returns anyway.
3) Are we obligated to inform A that she is obligated to
amend her 2000 tax return? If we had learned of the
transaction from an unrelated party, I think we would be,
but B has a vested interest in giving A a bad tax answer.
Get A's explanation. If it appears that she should amend
prior returns, then I'd certainly tell her. I have a
feeling that doing that would eliminate the need for
question 2.
4) Should we, and if so, how can we verify B's story and
determine whether A filed an incomplete return without
violating B's privacy rights?
How does B say she made the payments to A's relatives? If
by check something else that can be verified, that could be
enough.
5) Should we just fire them all, because we know too much?
Not yet. I think you have an obligation to get as much
information as you can and explain to everyone all the
implications and ramifications as best you can. After that
I suspect this problem will go away of its own accord.

Good luck.

Stu
 
D

David Woods, EA

Phoebe Roberts said:
We have a situation involving 3 clients.

A, a married individual, had a successful sole
proprietorship for many years. She incorporated it as a
C-corporation (C) in 2000. B, a single individual for the
years in question, became a 50% owner in C immediately after
C was incorporated. A, B and C became our clients in 2001.

B called us yesterday to say that she was leaving C
(abandoning her stock, quitting her job, taking her clients
and going home). A is aware of it and is unhappy. B's
question for us was: What are the tax consequences of my
disposition of my stock in C?

B's version of the story is that she purchased 50% of A's
shares in C immediately after incorporation (in 2000) for
$75,000. At A's request, she paid for her shares not with
one large check to A, but with smaller checks to A and A's
relatives, who then gave cash or stuff to A. B's
recollection is that A told her that A would get a better
tax answer that way.

B filed no gift tax return, and had no donative intent. A's
2000 income tax return (prepared by her spouse; we have a
copy along with an IRS notice regarding a math error for
that year which is consistent with the return we have) does
not report a sale of C stock. C's books do not reflect a
sale of C stock, other than the original issue of stock to
A.

We haven't asked A what her version of the transaction is;
however, B's version is plausible to us based on our other
experiences with A.

My questions:
1) Without making further attempts to verify B's story, can
we (legally / ethically) accept that her basis in her C
stock is $75,000?
2) Can we continue to prepare returns for A, B and C without
creating a conflict of interest, assuming that everyone
wants that to happen? (B has specifically stated that she
wants to continue as our client. A and C have combined
billings 10 times that of B, and have been excellent
referral sources. If forced to choose, we'd keep B and fire
A and C.)
3) Are we obligated to inform A that she is obligated to
amend her 2000 tax return? If we had learned of the
transaction from an unrelated party, I think we would be,
but B has a vested interest in giving A a bad tax answer.
4) Should we, and if so, how can we verify B's story and
determine whether A filed an incomplete return without
violating B's privacy rights? Our privacy policy says
(among other things) "If you engage in tax-related
transactions with another of our clients, we are required to
report those transactions consistently. For example, if
their records show they made taxable payments to you, we are
required to report those payments on your return. However,
we will not discuss your tax return with them."
5) Should we just fire them all, because we know too much?

Any thoughts (or commiserations) appreciated.
I would look at it this way. Correct me if certain
assumptions are incorrect. You have copies of all
individual and corporate tax returns for the periods in
question. If you cannot reconcile the stories and facts
with the amounts contained or not contained in the various
returns, then either someone neglected to inform you of a
sale or a gift or someone is being disingenuous. Either
way, I would make sure you have documented the story from
each of the people involved as a CYA measure.
 
M

MTW

MTW said:
I'd be tempted to fire them all, but I'll "stew" on that
further. <g>
I wonder if you could proceed in this manner: Draft a joint
letter to A and B pointing out (without being specific) that
in the course of preparing tax returns for each, information
has come to your attention to indicate that there is an
inconsistent position between the parties with regard to the
amount of B's investment in C stock. Invite the parties to
discuss and resolve this issue BETWEEN THEMSELVES and
apprise you of the outcome. (If they are unwilling or unable
to come to an agreement, then I would probably show them
both/all the door.)

Assuming that B is a bona fide shareholder of C, I believe
you could safely advise B that there is no indication on C's
returns to indicate an additional investment in stock.

Similarly, I believe you could safely advise A that there is
nothing on either A's or C's returns to indicate a sale or
issuance of stock to B.

What you probably can't do at this point is advise either
party on how to "best" resolve the situation from their
perspective (as that would appear to be "taking sides" in a
conflicted situation). Nor should you attempt to
intermediate between the parties. You can simply (I think)
ask them to collectively confirm the "facts."

MTW
 
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M

MTW

Our privacy policy says
(among other things) "If you engage in tax-related
transactions with another of our clients, we are required to
report those transactions consistently. For example, if
their records show they made taxable payments to you, we are
required to report those payments on your return. However,
we will not discuss your tax return with them."
I share Ed's concern about this policy statement. On one
hand, I REALLY LIKE IT because it gets this issue up on the
table. On the other, I would try to avoid locking yourself
into a PARTICULAR resolution, such as the second sentence
implies. Perhaps it would be better to say something like,
"For example, if their records show they made payments to
you, we are obliged to consider that fact when preparing
your return."

MTW
 
P

Phoebe Roberts, EA

"If you engage in tax-related
I'm not sure I agree with that statement being in your
policy, since it creates the very issue you have here--you
are now obligated to verify B's position and A can claim
that if you fail to do so and A is examined on the matter,
you failed to perform according to your agreement. That is,
you've indirectly told A that you would inform A if another
of your client's indicated that A has unreported income.
As a practical matter, we've used that as our out for taking
1099s (or K-1s) we prepare for Client1 and putting a copy
into Client2's file, without waiting for Client2 to hand
over the 1099 themselves. We have a lot of "related"
clients.

Do you have any suggested alternate wording, given that
we're unwilling to prepare completely inconsistent returns
for clients who do business with each other?
So which taxpayer do you force to be consistent with the
other?
In general, we assume that the entity with the better
records (corporation is better than individual, corp that
reconciles their bank statements is better than one that
doesn't, etc.) has better records. :)

Thanks!

Phoebe :)
 
P

Phoebe Roberts, EA

I talked to A, and her story was extremely vague but not
inconsistent with B's story. I've also come up with an
explanation that is consistent with everyone's story, is
consistent with everyone's prior tax returns, has a
relatively equitable tax result for everyone, and requires
no logical leaps or unbelievable assumptions. (The story
that A sold B stock in C for $75,000 requires a large
logical leap, since C's 1120 reported that the stock in C
was worth $500 immediately before the sale would have
occurred.)

We've also told both A and B that until the whole mess is
resolved to their mutual satisfaction, we can't advise
either of them how to structure the deal to their individual
benefit.

The plan is to get them to sit down together (with us) and
work out some mutually agreeable split. During that
meeting, we'll say, "This is the only scenario we can come
up with that fits all the facts we're aware of and what each
of you has explained to us. These are the tax consequences
of that scenario. Is that what happened, or is there
something else we should be aware of?"

Phoebe :)
 
H

Harlan Lunsford

William said:
I am not a tax professional. But, as a (retired) business
executive of high ethical standards, I believe I am
qualified to comment on your problem.

And, indeed, you might have a serious problem should you
continue to have any relationship with A, B or C. Unless I
am missing something, B's story plus A's tax return indicate
that they colluded to allow A to evade taxes. (I will leave
it to the pros as to whether you have any obligation to
report this.)
they colluded only IF B is telling the truth. And no, we
have no obligation to report or inform on clients, real or
imagined.
I would not outright "fire" them; but would sorrowfully tell
both parties that their separation causes you to have a
conflict of interest and that you cannot bring yourself to
choose between them. Say no more! Especially do not mention
to either the real problem caused by B's allegation. Should
their actions lead to legal procedures or IRS involvement,
you can then testify truthfully with a clear conscience and
without jeopardizing yourself.
After replying yesterday and then reading and replying to
Ed's reply today, and speaking personally, I like Bill,
would not be comfortable in having any further truck with
these people. Esp since Phoebe says she has some reasonable
doubt as to A's story given the history , and esp if B
cannot prove basis in (what I consider non existant) stock,
she trouble also.

No, I would just tell them all I am "readjusting the
priorities in my life and the doctor told me to take more
time off, and I want to travel to Scotland and... and.....
well, you getmydrift.

Cheer$,
Harlan Lunsford, EA n LA
 
E

Ed Zollars, CPA

As a practical matter, we've used that as our out for taking
1099s (or K-1s) we prepare for Client1 and putting a copy
into Client2's file, without waiting for Client2 to hand
over the 1099 themselves. We have a lot of "related"
clients.
I think you could handle that with Client1's engagement
letter, presuming that Client1 and Client2 are aware of the
fact that both are clients. You are now required under
Circular 230 to inform clients if you are representing
clients with potentially conflicting interests--and a payor
and a recipient would seem to have potentially conflicting
interests.
Do you have any suggested alternate wording, given that
we're unwilling to prepare completely inconsistent returns
for clients who do business with each other?
I would probably make it a bit more specific in terms of
whose information could be shared with whom. Because, as I
see it, your current broad statement is what is creating the
major problem here.
In general, we assume that the entity with the better
records (corporation is better than individual, corp that
reconciles their bank statements is better than one that
doesn't, etc.) has better records. :)
True, but that doesn't solve the matter in this case. And,
as well, it's possible that both records will be "less than
optimal" in which case it may be that neither set of records
are correct. At that point, you may be enforcing the
"foolish consistency" that Mr. Mencken complained about in
his famous quote <grin>.
 
H

Harlan Lunsford

I talked to A, and her story was extremely vague but not
inconsistent with B's story. I've also come up with an
explanation that is consistent with everyone's story, is
consistent with everyone's prior tax returns, has a
relatively equitable tax result for everyone, and requires
no logical leaps or unbelievable assumptions. (The story
that A sold B stock in C for $75,000 requires a large
logical leap, since C's 1120 reported that the stock in C
was worth $500 immediately before the sale would have
occurred.)

We've also told both A and B that until the whole mess is
resolved to their mutual satisfaction, we can't advise
either of them how to structure the deal to their individual
benefit.

The plan is to get them to sit down together (with us) and
work out some mutually agreeable split. During that
meeting, we'll say, "This is the only scenario we can come
up with that fits all the facts we're aware of and what each
of you has explained to us. These are the tax consequences
of that scenario. Is that what happened, or is there
something else we should be aware of?"
the 1120 value of 500$ for stock has no bearing on the case
whatsoever.

You said at first that B bought half of A's stock, i.e.
stock already issued by the corporation. But then you also
said that nothing on this was reflected by the corporate
books, i.e. no entries on the transfer log which properly
would have reflected the sale of 1/2 the nummer of shares
issued.

The t's have not been crossed, nor the i's dotted. Sounds
like a case of a lawyer, much as I hate to advise that.

Cheer$,
Harlan Lunsford, EA n LA
 
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P

Phoebe Roberts, EA

Harlan said:
You said at first that B bought half of A's stock, i.e.
stock already issued by the corporation. But then you also
said that nothing on this was reflected by the corporate
books
By books, I meant accounting books, not the transfer log
(which I've never seen and never wish to see). The only
conclusion I drew from the lack of appearance on the
(Quick)books was that B doesn't have 1244 stock (which would
have been an excellent answer) and that B had to have gotten
her stock from A.

Phoebe :)
 

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