Tax Lawyer's Blog

“None loves the messenger who brings bad news.”

 - Sophocles -

As I will explain in more detail later on, tax return preparation by its very nature requires the tax preparer to make legal judgments. Consequently, unenrolled tax preparers are engaged in the practice of law when they give their clients substantive tax law advice.

Historically, however, the federal government and the states have not pursued unenrolled preparers for making those legal judgments. But if the IRS’s proposal to license and regulate unenrolled preparers is any indication, that tradition is about to be scrapped.

The unauthorized practice of law

Brad Linder of Download Squad wrote about a 2007 9th Circuit Court Case that found two websites that offered assistance with the filing of bankruptcy claims guilty of practicing law without a license :

Henry Ihejirika ran the websites, Ziinet.com and 700law.com. He claimed that the websites were just clerical tools, providing customers with assistance in filling out their forms. But one client paid $219 to enter his personal information and was given a set of bankruptcy forms to sign.

It turns out there were errors in that form, and the client took Ihejirika to court, where a judge found that the websites provided more than clerical assistance, and that Ihejirika had “engaged in the unauthorized practice of the law.”

While this is good news for the client that had his bankruptcy files mangled, the ruling could make it difficult for similar businesses to set up shop online in the future.

Theoretically that could include automated tax preparation web sites or any other site that offers any sort of legal advice.

The emphasis is mine.

The Ohio State Bar Association’s William K. Weisenberg concisely states the purpose behind the rules prohibiting the unauthorized practice of law (UPL):

The purpose of the UPL provisions, whether in statute or by rule, is for the protection of the public. The provisions ensure that the public receives legal services by those who are trained, qualified and competent, and who have been tested and are subject to regulatory mechanisms. The beneficiary is the public–the client. That’s who we serve.

The emphasis, again, is mine.

In an article titled Crossing the Line: What CPAs Need to Know About the Unauthorized Practice of Law the author, Todd McCollough, spoke with Steven A. Martin, JD, CPA, a partner of Blaugrund, Herbert & Martin and legal counsel for The Ohio Society of CPAs about the unauthorized practice of law:

“CPAs [and unenrolled preparers] should not be forming business organizations, such as corporations or LLCs, on behalf of their clients. That means, do not prepare or file articles of organization or incorporation documents, agreements between owners, and other things of that nature. It’s clearly the practice of law.

[T]he Ohio Supreme Court fined a Piqua tax services company [Wyandt & Silvers] $20,000 in December 2005 for the unauthorized practice of law. The court ruled that the [business organization] forms Wyandt & Silvers completed constituted the unauthorized practice of law.

Martin added:

CPAs [but not unenrolled preparers] may advise clients on financial and tax issues that go closely along with forming a business, and that’s fine. Those things are crucially important, and they dovetail very closely with the organization of the business. However, the CPA should not be forming the organization on behalf of the client. That’s between the client and legal counsel.

There is no shortage of unenrolled preparers who render legal advice to their clients and the general public via their blogs and websites. That advice often involves the formation of a business entity. For example, listen to this unenrolled preparer talk about the legal benefits and detriments to choosing the corporate form of business (emphasis added):

While incorporating will certainly reduce one’s 1040 audit risk, it is more often than not NOT the best idea for the average sole proprietorship. Incorporation can generate much more paperwork, recordkeeping, federal and state tax filings, costs, and general all-round “agita” than it is worth.

I also recommend that all Schedule C businesses become an “LLC” – but it has nothing to do with taxes. Doing so adds an extra degree of liability protection.

This is clearly legal advice and constitutes the unauthorized practice of law in every state in the Union and probably Guam and Puerto Rico, too.

Tax advice and the practice of law

It’s perfectly understandable that an unenrolled preparer would render legal advice because it is simply impossible to separate the act of tax preparation from the act of rendering substantive legal advice. In short, where you have tax preparation you have tax law interpretation.

The tax code is a voluminous compilation of complex federal laws and the practice of interpreting it (for a fee) is, therefore, the practice of law. This, of course, means that all tax preparers, including CPAs, are to some degree engaging in the practice of law. Fortunately, an exception to the UPL rules has been made in the case of CPAs who practice tax law.

The reason for that exception is that tax preparation is not only about law. It’s also about accounting.

And I’m not talking about simple accounting either. For example, in addition to the obvious need for basic mathematical skills, tax preparers should have a good understanding of the equation for cost of goods sold, the LIFO and FIFO methods of accounting for inventory and the differences between the cash and accrual methods of accounting, all of which are topics in which CPAs have received extensive training. Footnote (1).

Similarly, the M-1 reconciliation on form 1120 demands that the tax preparer have a good understanding of the differences between GAAP (or other “book” basis of accounting) and tax financial statements. CPAs have been trained to understand this concept even if they don’t prepare tax returns because tax-book differences must be accounted for when making provisons for income taxes on the books of corporations (generally, not S corporations).

There are no exceptions or special rules that allow unenrolled preparers to practice law – tax or otherwise - without a law license. Footnote (2).

Again, up until now the federal government and most states have chosen not to vigorously enforce the UPL rules against unenrolled tax preparers. But that’s mostly because the IRS doesn’t currently have the tools available to determine who these unenrolled preparers are.

Of course, this isall about to change. And the primary reason it’s about to change is because unenrolled preparers, as a group, have, study after study, been shown to have a poor record of competence as tax preparers and advisors. Footnote (3).

Blanket advice

My blanket advice to everyone is as follows:

1. Never, under any circumstances, pay a non-lawyer for legal advice. If it is wrong, there will be serious and costly consequences and you will not be able to recover your losses through a malpractice insurance claim.
2. Never choose the sole proprietorship form of doing business. There simply is no upside (except for perhaps saving a few hundred bucks) and there is an awful lot of downside. In short, any business worth starting and operating is worth spending a few hundred bucks to incorporate or form as an LLC.
3. Never commingle your personal funds with your business funds. The problems commingling can create are myriad and I have written about them here and here.

Concluding remarks

As I’ve said before, I am in favor of the IRS’s licensing and regulating of tax preparers. When a currently unenrolled tax preparer qualifies himself under the new regulatory regime I will be the first one there to uncork the Dom Perignon and say, “congratulations, brother.”

If you are an incompetent or unscrupulous unenrolled preparer you have every reason to fear forthcoming IRS regulation. But if you are competent and honest, you should be heartened by the prospect of formal regulation and foaming at the bit at the chance to differentiate yourself from the merely mediocre and the miltantly dishonest.

Footnotes:

(1)  In anticipation of the inevitable motive questioning, let me make it clear that I have not formed the opinion that essential skills for tax preparation are proficiency in accounting and interpretation of the tax laws because I am a lawyer and an accountant, but rather because 25 years of experience have convinced me that it is true.

(2)  Because federal law supercedes state law IRS Enrolled Agents are free to operate within the constraints of their EA license without fear of state prosecution.

(3)  This is hardly surprising given the fact that the tax code is daunting even for experienced professionals who have had extensive training and experience in law or accounting. I can only imagine how difficult it must be for people lacking a background in both law and accounting?

Bookmark & Share: