Working with an accountant usually is a smart strategy for handling your taxes and tax planning. More than 80 percent of small business owners do just that. However, be aware that your accountant may not tell you everything you’d want to know.
1. Your disclosures to your accountant may not be privileged
You know that anything you say to your attorney is privileged; it’s a right created by common law. But there is no such common law privilege for accountants and their clients. There is a limited privilege, which was created by statute in 1998 for a federally-authorized tax practitioner—CPAs, enrolled agents and enrolled actuaries—and his or her client. What you say to your accountant may or may not be privileged.
Scope of federal privilege: The limited privilege applies to disclosures to accountants to the same extent that they would for disclosures to an attorney. Thus, your accountant can give you advice about a tax question you raise. However, the privilege may be asserted only in civil matters before the IRS or before any noncriminal tax proceeding brought in federal court by or against the United States. The privilege does not apply to:
- State taxes, such as state income taxes
- Criminal proceedings, such as a criminal tax prosecution
- Preparation of a tax return
- Any civil proceeding involving a tax shelter
State-level privilege: In some states, including Florida, Pennsylvania, Colorado and Missouri, there is accountant-client privilege. If you have any concerns about what you tell your accountant, first ask about whether state-level privilege applies to you.
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Best strategy: When in doubt about discussing highly-sensitive tax matters that could potentially lead to a criminal case, talk to an attorney; all communications are privileged.
2. Specific entries or omissions on your return that may cause audits
Your accountant isn’t being evasive; he or she just doesn’t know for sure in most cases because the IRS isn’t talking.
There are some tax issues that everyone knows are subject to special IRS scrutiny, such as worker classification. The IRS is always looking at businesses to see whether workers have been treated as employees, rather than as independent contractors, where it is appropriate to do so.
However, other tax issues, such as claiming a home office deduction, are not guaranteed audit red flags. The IRS doesn’t publish a list for most of its audit targets, although from time to time it does say at which issues it will look closely. For example, it has put the research credit in its crosshairs for large and mid-sized businesses by designating it as a “Tier 1 issue,” and will look at every return on which the credit is claimed. Whether the same scrutiny is applied for research credits claimed by small businesses isn’t clear.
Best strategy: To minimize any audit exposure, make sure that there is a basis for taking a deduction or other tax position, as well as having all necessary documentation to support the position.
3. Who is actually preparing your return
You’ve met with your accountant, but is he or she the person who is preparing your return? If you use an accounting firm, your return may be delegated to young associates or even temporary employees. This isn’t necessarily a bad thing, but you’d certainly like to know about it.
Today, as a cost-saver to firms, tax returns are increasingly being outsourced to preparers in other parts of the country or even overseas. In 2008, new IRS regulations directed tax preparers to obtain consent from clients before disclosing information to third-party tax preparers located outside the U.S. However, this rule does not apply when outsourcing to preparers in the U.S.; firms can disclose a client’s tax information to another preparer in the U.S. without obtaining client consent.
Best strategy: Just ask your accountant who is preparing your return. Likely your accountant will review any return prepared by someone else. Once your accountant adds his or her signature to your return, you can look to this preparer for responsibility for any preparation problems on the return.