Welcome to chapter 4 where I will discuss everything you need to know concerning legal duties and responsibilities for tax return preparers. Here are today’s learning outcomes:
- Summarize the tax return preparer’s common law duties and liabilities to clients and third parties.
- Identify situations which result in violations of the tax return preparer’s common law duties and liabilities to clients and third parties.
Breach of Contract
Breach of contract is not what tax preparers usually get sued over but it does happen. Breach of contract usually occurs when a tax preparer fails to do the work or fails to do the work in a timely manner.
The following are a few elements that need to be present for breach of contract to exist:
- A Contract must exist – in order to prove breach of contract you must first prove that their was a contract in the first place. Contracts can be written, oral, or even implied.
- “Hey Bob can you do my taxes this year? $100? Ok I’ll send you over my tax data today.”
- One end of the deal was executed – If a client sues you for not doing their taxes but failed to send over any tax data then it’s hard to prove breach of contract. If the client did their part (paid a retainer for example) then there can be breach of contract if the tax preparer doesn’t hold up their end of the deal.
- Breach occurred – This might seem self-evident but to prove breach of contract you must prove their was an actual breach of the contract. Some common examples are as follows:
- Client sent in tax data and preparer never completed the return.
- Client sent in tax data in a timely manner but the preparer filed the return late.
- Accountant filed incomplete or incorrect returns.
- Damages occurred – Client must prove that there were damages. For example, if the accountant filed the return late and there was penalties then the client can sue to be compensated for those penalties. However, they can’t claim punitive damages.
Defenses for breach of contract – There are several defenses tax preparers can use to avoid being liable for breach of contract:
- Too much time has passed – If the statute of limitation passes then you might avoid breach of contract lawsuits.
- The client was sketchy or unresponsive – If the client wants you to do illegal stuff, sends sketchy documentation, says they won’t pay their bill but expects you to do the work, then you can avoid breach of contract.
- Substantial performance was done – If the accountant spent hours and hours of work completing a complex tax return but filed the return a few days late then the client can’t request a full refund of the accounting fees. They may be compensated for the penalties due if they prove breach of contract existed.
Negligence is where most tax preparers get in trouble. It’s not that they didn’t do the work or made mistakes – it’s that they were careless in their actions. Here are the main elements of negligence (often called malpractice):
- Duty of care – There must be a ‘duty of care’ for a case of negligence to exist. Generally if there is a contract between a client and a tax preparer then a duty of care exist (even if it’s not spelled out in the engagement letter).
- Preparer breached duty of care – The key word here is careless. Negligence means a tax preparer was careless while fraud means the tax preparer was intentional. This is based on a reasonable standard – would a reasonable accountant be this careless?
- Tax preparer carelessly files tax return really late
- Tax preparer carelessly files the wrong forms
- Tax preparer carelessly gives tax advice that doesn’t have intended tax savings
- Breach caused direct injury – “If it wasn’t for the tax preparer’s actions the client would not suffer an injury.” This is called a direct causation and means that the tax preparer’s actions would reasonably cause a direct injury to the taxpayer.
- Damages occur – The client can sue for compensatory damages (pay me back for the damage done) but not for punitive damages (I want to be compensated above and beyond what you cost me).
Defenses – Here are some common defenses:
- Statute of limitation – client didn’t sue on time.
- Client is negligent as well – If a client sends their tax info the day before the due date then it’s not the tax preparer’s fault if the return was filed late.
- Tax preparer can prove 1 element didn’t exist – if one of the 4 elements of negligence doesn’t exist then negligence itself doesn’t exist.
Fraud is where it gets really bad and it’s the hardest to prove. The other two you only have to prove beyond a “preponderance of the evidence” (more likely true than not). For fraud to exist you have to prove that the tax preparer was intentional and that they knew that they were being reckless or knowingly committed fraud. Here are the elements of fraud:
- False representation of facts – either omitted information or told straight lies
- Misrepresentation was material – It was a big lie or big omission. Small lies are still actionable but they may not meet the standard of fraud.
- Tax preparer intentionally omitted information or lied – If the tax preparer was intentionally reckless and said things like “lets deduct all your personal expenses and the IRS will never find out,” then that’s being intentionally reckless.
- The client relied upon the information – The client expects the tax preparer to know what they are talking about. If the tax preparer gives false information and the client relies on that information then that’s one step closer to committing fraud.
- Damages occurred – Like in most cases – damages must occur.
Remember: the keyword here is “intentional.” Negligence is being careless and fraud is being intentional.
Liability to Third Party
I already gave out a ton of information in this article so I’ll be brief with the third-party liabilities.
- Limited scope for breach of contract and negligence (must be an intended beneficiary i.e. trust and estates.)
- Incidental beneficiaries can’t sue (Bob couldn’t deduct his business expenses so his business closed down and he was unable to pay the rent on his apartment … his landlord can’t sue his accountant).
- Fraud opens things up to a broader group of people to sue. Since the fraud was intentional the requirement to sue are more lax.
- Breach of contract is for not doing the work or not doing it on time.
- Negligence is when you’re careless but not intentionally making mistakes.
- Fraud is when you are intentionally doing something wrong.
- Easier to prove breach of contract and negligence than fraud.