Hot Topics June

Economic Reality Audits Could Threaten Accountants and Tax Preparers with Malpractice.

The IRS's new concern with the total financial situation of a taxpayer being audited (called "economic reality" audits) could place accountants and tax preparers (collectively "accountant") in a precarious position. These audits focus on "life style" issues such as the value of the taxpayer's home(s) and automobile(s), unreported cash transactions, cash on hand, and contents of safe deposit boxes, rather than just being concerned with items reported on the tax return.

The problem arises since accountants do not enjoy the confidentiality privilege afforded attorneys. If the IRS asks questions of the accountant that involve life style issues, rather than items listed on the tax return, and the answer could lead the disclosure of improper activity, the accountant is legally obligated to divulge the taxpayer's answers. If the accountant then divulges such information, he or she could be sued for malpractice for causing harm to the client.

Accountants should exercise caution with respect to an economic reality audit. They should instruct the client, in writing, to consult with an attorney before answering any questions regarding cash transactions or other life style issues that do not appear on the tax return.

Law Firm Can Deduct Litigation Costs Expended on Behalf of Clients under A Gross Fee Contract.

The Ninth Circuit Court of Appeals in Boccardo v. Cm. (No. 93-70850, 5/26/95) has ruled that a law firm may deduct the costs of litigation, such as filing fees, witness fees, travel expenses and medical consultation fees, under a gross recovery contract, since the client is not obligated to reimburse the firm for its incurred costs. Under this type of fee arrangement, the law firm can make a profit only if it derives revenues in excess of its costs.

The Ninth Circuit overruled the Tax Court which held that such expenditures were costs advanced on behalf of the client and had to be treated as loans. The Tax Court erred when it labeled litigation costs as a loan when the client was under no obligation to repay those costs. In contrast, under a "net" fee arrangement, litigation costs are treated as loans and are nondeductible, since the client is obligated to pay for those costs.

The court was not concerned that a gross fee arrangement violated California Rules of Professional Conduct (which prohibits the attorney from paying the costs of a lawsuit) since there was no evidence that the State Bar enforced the provision.

Congressional Report on Expatriation Tax Avoidance

The Joint Committee on Taxation staff released its report on expatriation tax avoidance. The report disagreed with many of the Treasury Department's findings with respect to the proposed new tax (which, in general treats an expatriating citizen or resident as having sold his or her property in a taxable transaction upon renunciation of citizenship or residency). Specifically, over the last 10 years, only 4 super-wealthy U.S. citizens renounced their U.S. citizenship to avoid taxes.

Some of the recommendations made included: (i) narrowing the law to exclude green card holders, thereby avoiding problems for world-wide corporations who move personnel to and from the U.S.; (ii) excluding assets that produce foreign-source income, a concern of U.S. citizens that have lived overseas for many years; and (iii) eliminating those who move to a country with a tax rate roughly equal to that in the U.S.

The House Ways and Means Committee has promised to introduce legislation addressing the expatriation problem.

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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**