The Amended Return and the Preparer's Circular 230 Exposure
Dana, a CPA, prepared the 2023 Form 1040 for her client Marcus, a cash-basis sole proprietor. Marcus gave Dana a summary spreadsheet showing gross receipts of $310,000 and expenses of $180,000. In November 2024, Marcus calls Dana and admits he left a $42,000 cash deposit off the spreadsheet because he was 'nervous about the bank reporting.' He asks Dana to amend the return and says, 'Just fix it quietly, no need to explain anything to the IRS.' Dana calculates that the omitted income creates additional tax of about $11,000. Marcus has no history of penalties and is willing to pay in full. Dana is unsure whether she must notify the IRS of the error, whether she can prepare the amended return at all, and what her own obligations are.
1. Does Dana have an affirmative duty to notify the IRS of Marcus's understatement, or may she simply prepare a properly disclosed amended return?
Read the worked answer
Dana has no affirmative duty to notify the IRS of the client's error. Circular 230 §10.21 governs knowledge of a client's omission: if a practitioner knows the client has not complied with revenue laws or has made an error or omission on a return, the practitioner must advise the client promptly of the fact and the consequences of the noncompliance, error, or omission. The duty is to advise the client - not to report the client.
The client retains the decision. If Marcus chooses to correct the return, Dana may prepare a superseding/amended return that accurately reports the $42,000. Because the return as filed is being corrected, the disclosure is made through the amended return itself, and Dana is not required to file a separate report with the IRS.
Key point tested: the exam distinguishes advising the client (mandatory) from disclosing the client's conduct to the IRS (not required, and generally barred absent client consent under §10.51 confidentiality). Dana should document her advice in the engagement file.
2. Marcus instructs Dana to leave the $42,000 off the amended return as well. What are Dana's obligations, and may she continue to represent Marcus?
Read the worked answer
Dana may not prepare or sign a return she knows understates income. Under Circular 230 §10.34(a), a practitioner may not sign a return or advise a position unless there is a reasonable basis for the position and the position is not frivolous. A known omission of $42,000 of receipts fails this standard. Under §10.34(a)(1)(ii), if the client insists on an improper position, the practitioner must advise the client of the penalties and consequences and withdraw rather than sign.
Dana should:
- Refuse to prepare the false amended return.
- Advise Marcus in writing of the consequences (accuracy-related penalty under §6662; potential §6663 civil fraud if intentional).
- Withdraw from the engagement if he persists, and take reasonable steps to avoid a foreseeable harm to the client (§10.21 / §10.23 diligence).
She may continue to represent Marcus on other, unrelated matters only if she is not facilitating the improper position. She must not disclose the reason for withdrawal to the IRS without consent. Note: Dana's own preparer penalty exposure under §6694 arises only if she actually signs or prepares the improper return - refusing protects her.
3. Separately, Dana is behind on her own continuing professional education. She completed only 24 of the 40 required CPE hours this year. Does this affect her ability to sign Marcus's return, and what is her exposure?
Read the worked answer
CPE noncompliance does not by itself make Dana's signature on a return improper - the return-preparation standards (§10.34) turn on the position's basis, not on the preparer's CPE status. However, CPE is a Circular 230 §10.6 obligation: a practitioner must complete the required continuing education hours each year to maintain eligibility to practice before the IRS.
Consequences of a shortfall are generally handled by the IRS Office of Professional Responsibility - possible reprimand, or in serious/repeat cases, suspension or disallowance of practice. It is not a per-return preparer penalty under §6694 or §6701.
Practical guidance: Dana should make up the hours as soon as the program permits and retain records (§10.6(f) recordkeeping). She should not sign returns she cannot support on the merits - the CPE issue and the Marcus issue are independent. The exam frequently tests that CPE is an eligibility requirement administered by OPR, distinct from the return-position standards.