for Tax Preparers Part I

for Tax Preparers Part I

Table of Contents 1. Introduction... 1 2. Training Objectives... 2 3. Resources... 3 4. Ethics Overview... 4 a. Ethical Behavior... 4 i. Applied Ethics... 4 b. Business Ethics... 5 c. Ethics for Tax Preparers... 5 d. Unethical Behavior... 6 i. Recent Scandals... 6 a. Enron... 7 b. Bernard Bernie Madoff... 7 c. Tax Evasion... 8 d. Insider Trading... 8 5. Rules Governing Tax Preparers... 10 6. Consequences of Unethical Behavior... 11 a. The Enron Case... 11 b. The Sarbanes-Oxley Act (SOX)... 12 7. Being Ethical... 13 8. Organizations and Acts Supporting Ethical Practice... 15 a. The Small Business and Work Opportunity Act (SBWOA)... 15 b. The American Institute of CPAs (AICPA)... 15 c. The Public Company Accounting Oversight Board (PCAOB)... 15 d. International Financial Reporting Standards (IFRS)... 15 e. The United States Generally Accepted Accounting Principles (GAAP). 15 9. Whistle Blowers... 16 10.... 17 11. Glossary... 18 i

Ethics for Tax Preparers: Part I 1. Introduction Ethics in life are much like ethics in business Acting ethically is a way of attempting to do the right thing when a simple right or wrong option isn t clearly available. Ethics is a system of morals, and establishes rules governing conduct as accepted by a group or culture. Ethics is the practice of moral principles guiding one in moral behavior, and can be applied to individuals in life, in business, and how companies conduct business. 1

2. Training Objectives When you have completed this training, you will: Be familiar with the general terms associated with ethics. Understand the difference between legal behavior and moral behavior. Know what is considered ethical conduct in business and tax preparation. Understand the consequences of unethical business behavior. Be familiar with the resources at your disposal. 2

3. Resources IRS Circular 230, Regulations Governing Practice before the Internal Revenue Service American Institute of CPAs (AICPA) Code of Professional Conduct IRS Form 14157, Complaint: Tax Return Preparer 3

4. Ethics Overview a. Ethical behavior, also known as moral behavior, refers to acting upon the distinction between right and wrong conduct, rather than relying simply on the legal issue at hand, or acting in a way simply because it is customary to do so. i. Applied ethics refers to the discipline of philosophy that attempts to apply ethics to real-life. Applied ethics is often practiced in establishing public policy, and often ask similar questions that individuals grapple with themselves. Establishing right and wrong for every situation is nearly impossible, and often comes down to personal beliefs. Asking ethical questions usually leads to more questions and scenarios to which the ethic is applied. Example: Is lying always wrong? and, If lying isn t always wrong, when is it permissible? Is abortion immoral? and, In what situations is abortion moral? 4

Establishing ethical guidelines and seeking answers is not always as simple as a yes or no question, such as those in the example. Most often in real life, the situations that require individuals to weigh the factors determining ethical behavior are often complex. Example: You are a paramedic and come across the scene of a car crash. Horrified, you see your husband behind the wheel, injured very severely. Beside him is a beautiful young woman, bleeding profusely. Your husband s eyes tell you that she is his lover, with whom he has been having an affair, as he whispers, I m sorry and loses consciousness. You must stop the flow of blood in order to save the woman s life, but to do so will mean that you cannot tend to your husband, who may die anyway. If you tend to your husband first, the woman will most certainly die from blood loss. What is the most ethical thing to do in this situation? It is situations such as these that require individuals and corporations to employ ethical judgment and make it impossible for government to regulate every possible scenario of right and wrong. b. Business ethics, also sometimes referred to as corporate ethics or professional ethics, refers to the actions and decisions that are beyond the reach of what the government can regulate or specifically define. c. Ethics for tax preparers is of utmost importance. Accountants, tax preparers, and auditors must employ a high level of ethics to be fair to all parties concerned. The most ethical choice is not always one that benefits the company most profitably. Ethics is so important for these professions that countries have specific legislation focused on enforcing ethical behavior: Germany has established tax law, Sweden uses accounting law, the United Kingdom relies on company law. Each of these countries has established organizations that oversee the laws, and in the United States that is the Financial Accounting Standards Board (FASB). 5

d. Unethical behavior is behavior that does not conform to the accepted and expected standards of society. For businesses, unethical behavior is that which does not conform to accepted and expected standards of professional behavior. Example: Cheating is wrong. The rich should not take from the poor. Harming others for personal gain is always wrong. a. Recent scandals show us that, unfortunately, there is no shortage of real-life examples of unethical behavior in business, some of which have lead to corporate collapses and economic hardship for numerous individuals. Since the 1980s, highly publicized cases of attempted bankruptcy protection, charges of fraud, and other creative accounting practices sometimes involving misleading information and even bribery have made some companies names synonymous with treachery and deceit. But not all unethical practices lead to scandals. Sometimes, because businesses aren t actually breaking any laws, they are able to get away with what most consider wrong or unprofessional practices. Of course the damage is done to their professional reputations. 6

Example: Walmart, the largest revenue-producing company in the world (over $400 billion), is often in the media for its questionable business practices. From paying very low wages to its thousands of employees, to a pronounced lack of employee benefits, to even suing a severely injured employee for $470,000 in medical costs forcing the employee to survive on social security and Medicare a suit which Walmart won only because of the fine print in a contract. Walmart may be legally in the right on many of these issues, but the vast public outcry makes it clear that in the eyes of most, Walmart is ethically in the wrong. Scandalous situations have also created a distrust of the accounting profession resulting in long-term damage to the profession s reputation. a. Enron, a multinational company, used illegal accounting practices by presenting false information on their financial statements. Arthur Anderson, a very well-known accounting firm, confirmed the false information as accurate. The devastation from this deceit resulted in a loss of over $25 billion to shareholders, and the loss of over 85,000 jobs. b. Bernard Bernie Madoff established Bernard L. Madoff Investment Securities LLC in 1960. Despite reported suspicions arising from his unbelievable claims on investment returns, Madoff was able to obtain clients and their investments until his arrest in 2008. Madoff used two employees to create false reports, backdating trades to obtain the required profit. Madoff told clients he was investing their money, but instead deposited client money into his own bank account where it steadily grew for his own personal use, while his clients planned their lives around the false gains they believed their investments were 7

accruing. Madoff s sons learned of his deceit and reported their father to the FBI. Madoff s reports created a loss of $57 billion dollars in terms of what clients thought they had earned, and an actual loss of between $10 and $20 billion to investors. c. Tax evasion vs tax avoidance. Tax evasion is the deliberate misrepresentation of income, profits, or gains in order to reduce a tax liability. Tax avoidance is to legally use the tax system to reduce the amount of tax owed. Tax avoidance is legal and is encouraged while tax evasion is illegal. Example: A company reports only its credit card transactions as income, rather than reporting credit card payments and cash payments. This reduces the company s income. The company also inflates the expenses associated with running the business, thereby reducing the profit and taxable income. This is an example of tax evasion. An individual keeps a log of expenses and contributions to charity, and claims dependents as tax deductions. These are all examples of tax avoidance. d. Insider trading can come in many forms and can be inside employees, outside friends or family, or those who regulate the law: Employees involved in trading a company s securities after learning of inside, confidential developments Confidential information is shared with outsiders (nonemployees), known as tipping them off, allowing them to trade securities based on the information 8

Law enforcement officials, and those in the banking and brokerage industries who are hired to assist with such trades Government officials who have knowledge of such trades Any person who takes advantage of confidential information Example: The employees of a company learn that an anticipated contract with the government has been lost, though the information has not been released publically. The employees quickly sell their stock based on the information. 9

5. Rules Governing Tax Preparers Rules governing tax preparers can be found in IRS Circular No. 230. The circular includes information on: Who can practice tax preparation Issues of conflicts of interest Responsibilities Limitations and restrictions Standards for best practices Sanctions and consequences Broadly speaking, tax preparers have the following responsibilities. Tax preparers: Must act in the best interests of their clients Must provide transparency and disclosure Must not place their own interests above their client s interests Must adhere to the ethics and standards of their profession Should provide the maximum amount of protection for their clients allowable under law 10

6. Consequences of Unethical Behavior There is no question that the damage of unethical business practices is farreaching. The consequences for the individuals responsible are often severe, though some would argue, not severe enough. a. In the Enron case, many of the Enron executives were sentenced to prison, and the auditor, Arthur Anderson, was eventually found guilty in a court of law. Before the verdict on Arthur Anderson, their reputation had diminished so much that the company had lost most of its clients and gone out of business. The view of unethical behavior by clients and the public can have more serious and long-term effects than any punishment doled out by the courts. Because of the Enron scandal and others similar to it, new legislations have been put in place to further ensure accurate reporting and transparency for public companies. Example: An area of a busy highway is undeveloped, because it is a wetland habitat. A car dealer purchases the property and even though the contract stipulates that the land cannot be developed due to environmental protection efforts. The car dealer brings in bulldozers and begins to destroy the wetlands before anyone can stop them. The car dealer is fined 11

for the destruction, but is allowed to continue to develop the land, because the wetland has already been destroyed and there is no hope of renovating for wildlife. The car dealer weighed the costs of the fine for destroying the wildlife against the potential benefits gained from having a business on that busy stretch of highway, and determined that monetarily, the fine was worth the destruction. b. The Sarbanes-Oxley Act (SOX) is a piece of legislation put in place post- Enron that increased repercussions for any fabrication or destroying of records in order to defraud shareholders. The act holds auditing firms accountable for remaining unbiased and independent of their clients, and covers such items as: Corporate board responsibility Criminal penalties SEC involvement on rulings Auditor independence Corporate governance Internal control assessment Enhanced financial disclosure Note: Australia, France, Germany, India, Italy, Japan, South Africa, and Turkey have enacted laws similar to SOX, indicating the need for stricter financial regulating is a global issue. 12

7. Being Ethical Some argue that being ethical cannot be taught. Rather, it must be practiced. Ethics come into our lives daily, and asking ethical questions on a regular basis helps individuals and business professionals alike to weigh the rights and wrongs of situations. Some questions to ask of oneself in given situations are: Who stands to benefit the most? How many people are affected? Are lives lost? Human, animal, or environmental impacts? Is the decision based on personal economic gain at the expense of others? Is there deceit involved? These questions can help an individual weigh the pros and cons of the options available, allowing a balanced decision to be made. If ethical questions are not asked, there is no way to balance the true outcomes and consequences. However, it is important to recognize that not all situations will have clear solutions, even after carefully weighing all the options. 13

Example: An accountant discovers information that a company is using fraudulent practices to evade payment of taxes. The practices, if discovered, are sure to put the company out of business, costing 12,000 people their jobs. If the accountant destroys the information, no one will ever find out the company has been getting away with paying hundreds of thousands of dollars less in taxes. Should the accountant report the company, costing 12,000 people including himself their jobs, or should he save those jobs by destroying the evidence, which would allow the company to continue its fraudulent practices? 14

8. Organizations and Acts Supporting Ethical Practice There are numerous organizations and Acts in place more recently to help regulate and define ethical behavior for professionals in tax preparation and accounting. a. The Small Business and Work Opportunity Act (SBWOA) increases the accuracy threshold for small business to a 51% likelihood that a tax return is accurate, (raised from a 33% likelihood). b. The American Institute of CPAs (AICPA) established the Code of Professional Conduct for accountant responsibility to act with integrity, objectivity, and due care. c. The Public Company Accounting Oversight Board (PCAOB) is charged with regulating, overseeing, inspecting, and disciplining accounting firms in their roles as auditors of public companies. d. International Accounting Standards Board developed the International Financial Reporting Standards (IFRS) based on principles, and is used by over 115 countries. e. The United States Generally Accepted Accounting Principles (GAAP) is the standard for accounting practice and is based primarily on rules. GAAP has been criticized for its focus on rules, and blamed as partly responsible for the scandals witnessed in recent years. 15

9. Whistle Blowers Whistle blowers have not only the right to report complaints against professionals, but are also encouraged to do so. For example, IRS Form 14157, Complaint: Tax Return Preparer, provides the whistle blower with a method to report tax return preparers for unethical conduct. Additionally, many companies have established hotlines to allow whistle blowers to more easily report concerns, and by doing so, perhaps reestablishing reputations. 16

10. Glossary Applied ethics: the discipline of philosophy that attempts to apply ethics to real life. Business ethics: Also sometimes referred to as corporate ethics or professional ethics, refers to the actions and decisions that are beyond the reach of what the government can regulate or specifically define. Moral behavior: acting up on the distinction between right and wrong conduct, rather than relying on the legal issue at hand, or acting in a way simply because it is customary to do so. Unethical behavior: behavior that does not conform to the accepted and expected standards of society. Whistle blower: a person who tells the public or someone in authority about alleged dishonest or illegal activities occurring in a government department, a public or private organization, or a company. 17

18