Whether to amend a return

As long as a human element is an integral part of the tax return preparation process, errors and omissions on tax returns will remain commonplace. Whether an error or omission is merely typographical, a product of flawed interpretation of a complicated body of tax law, or the result of a misconstruction of the underlying facts, tax practitioners are frequently confronted with issues regarding the accuracy of a previously filed tax return. The decision to file an amended return to correct one or more errors or omissions involves a variety of considerations.

Practitioners and clients must determine whether the cost of making the correction, i.e., the professional fees, justifies the anticipated result. An amended return that represents a large prospective refund claim, for example, is often worth the time and expense to prepare. On the other hand, correcting a transcriptional error or minor omission that would only slightly change a tax liability may be unjustifiable, given the cost involved.

Practitioners and clients must also determine their respective levels of risk averseness. An amended return can protect a client from accuracy-related penalties imposed by Sec. 6662 for an understatement of tax shown on an originally filed return. The comfort level of practitioners and clients with respect to the risk of these penalties plays a large role in the decision to file an amended return. While some practitioners are content to “play the audit lottery,” others are determined to correct an error or omission of any magnitude, no matter the cost.

In addition, practitioners may be reluctant to inform a client of an error discovered on an originally filed return if the error resulted from the practitioner’s misinterpretation of the facts or law or other action. Though practitioners are generally required to notify clients of any errors they discover, practitioners may be reluctant to disclose these errors, to limit exposure for professional malpractice or to maintain an image of infallibility with the client. All of these factors play a role in deciding whether to file an amended return to correct errors or omissions on an originally filed return.

A ‘CREATURE OF ADMINISTRATIVE GRACE’

Because errors and omissions on tax returns are common, many practitioners consider amended returns to be an integral component of the tax compliance process. Despite this, the term “amended return” or its equivalent does not appear anywhere in the Code; thus, amended returns are not authorized by statute. Rather, amended returns are “a creature of administrative origin and grace” (Badaracco, 464 U.S. 386 (1984)).

The IRS’s long-standing administrative practice is to recognize amended returns that correct clear errors or plain mistakes on originally filed tax returns (Klinghamer v. Brodrick, 242 F.2d 563 (10th Cir. 1957)). Despite this, the treatment of an amended return is a matter of administrative discretion (Fayeghi, 211 F.3d 504 (9th Cir. 2000)). As a result, the IRS’s refusal to accept an amended return is subject to judicial review only for abuse of discretion (Miskovsky, 414 F.2d 954 (3d Cir. 1969)).

If the IRS has the discretion to accept or reject an amended return, the question then arises: Is a taxpayer required to file an amended return when an error or omission is discovered on an originally filed tax return? Regs. Sec. 1.451-1(a) states that “if a taxpayer ascertains that an item should have been included in gross income in a prior taxable year, [the taxpayer] should, if within the period of limitation, file an amended return and pay any additional tax due” (emphasis added). Regs. Sec. 1.461-1(a)(3) contains similar “should” language with respect to amended returns and the discovery of erroneous deductions taken in prior years.

The Supreme Court held that, despite these and other references to amended returns in the Treasury regulations, “[n]one of these provisions, however, requires the filing of [an amended return]” (Badaracco, at 397). Similarly, the Tax Court held that taxpayers are not required by statute to file an amended return when an originally filed tax return is discovered to be incorrect and that the failure to file an amended return in this context does not, by itself, establish an intent to evade tax (Broadhead, T.C. Memo. 1955-328).

CIRCULAR 230 AND SSTS CONCERNS

While taxpayers are not required, by statute or otherwise, to file amended returns to correct errors or omissions, tax practitioners are held to a higher, albeit different, standard. Practitioners authorized to practice and represent taxpayers before the IRS are bound by Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10). Section 10.21 of Circular 230 requires any practitioner who knows or discovers that a client has not complied with the federal tax laws or that a client has made an error or omission on any return, document, affidavit, or other paper submitted or executed under the federal tax laws must advise the client promptly of the noncompliance, error, or omission and its consequences. However, nothing in Circular 230 requires correction of the noncompliance, error, or omission or disengagement when the client refuses to make the correction. Ultimately, the option to correct is at the client’s discretion.

The AICPA takes a similar approach in paragraph 7 of Statement on Standards for Tax Services (SSTS) No. 6, Knowledge of Error: Return Preparation and Administrative Proceedings: “The member should advise the taxpayer of the error and the potential consequences, and recommend the measures to be taken.” SSTS No. 6, paragraph 8, continues: “It is the taxpayer’s responsibility to decide whether to correct the error. … Although recognizing that the taxpayer may not be required by statute to correct an error by filing an amended return, a member should consider whether a taxpayer’s decision not to file an amended return or otherwise correct an error may predict future behavior that might require termination of the relationship.”

Similarly, tax attorneys and CPAs should be cognizant of any ethical requirements imposed by their respective state bar associations and governing bodies.

In short, practitioners are generally required to inform clients of any errors or omissions discovered on originally filed tax returns and recommend that those errors or omissions be corrected. However, this does not appear to bar a practitioner from also informing the client that there is no requirement to file an amended return, provided the practitioner clearly outlines the potential consequences of not doing so. As with any practitioner-client interaction, the ultimate decision usually rests with the client, but the practitioner has a duty to ensure the client is in the best position to make the proper decision, given all the facts and circumstances.

Editor’s note: A version of this column appeared in the January 2017 issue of The Tax Adviser as “Tax Trends: Decision to Amend Ultimately Falls to the Client.”

Ryan Lardinois (ryan.lardinois@bakertilly.com) is a senior tax associate with Baker Tilly Virchow Krause LLP, Chicago.

To comment on this article or to suggest an idea for another article, contact Paul Bonner, senior editor, at pbonner@aicpa.org or 919-402-4434.