Discussion:Deduction taken in wrong year

The argument being made is, that over the two years, the total taxes are correct and that if 2007 is audited and the mistake is found, the IRS would not want to adjust 2007 since then we would go back & amend 2006 anyway and the government might even come out behind after interest is figured in.

The amounts involved are substantial - six figures.

What do you all think?

Thanks a million for your help on this one.

On the other hand, I think I may need to tell my client (who is the controlling shareholder) that I can't let him sign a 2007 form 1040 that contains a six figure deduction that he knows is incorrect. As for signing the 1120S, that's really not my problem since I don't prepare it.

I just have to think about the many many tax battles that are all about timing, often over only one or two years - inventory valuation, accounting method, fiscal year, etc.

I may have some free time soon as a result of a smaller client list. (That's OK - tax season will soon be upon us.)

Sorry to hear about the test, Donnie. Some of the most brilliant accountants I know just aren't test takers (and the reverse as well).

But, I still can't get past being very queezy about my client (and myself) putting a signature on a tax return that we're all on record as knowing understates income by over $100K.

Smokey, maybe you can be our guinea pig and make a disclosure under the new MLTN standard.

Search: Doctrine of Equitable Recoupment - [1]

Paul puts it very nicely and reminds us how relevant this is.

You could get hit with preparer penalties as well as you have a fiduciary responsibility to other shareholders.

A large company such as this must/should recognize that mistakes are made and doing the right thing here is key. A small item I would simply deduct in 2007 say 10K or less. But 6 figures, ten shareholders, several states...... I would amend.

Since it's an S corporation, do you all think it would be legal to simply forgo taking the missed deduction?

When the corporation is sold, then the basis, as calculated from the figures on the K-1's over the years, would be higher than if the amended returns were submitted and the deduction taken. Therefore, the tax on cap gains would be lower, resulting in some tax benefit.

Of course if the corporation shares ended up with a step-up in basis in any of the shareholders' estates, this plan wouldn't help. Plus the tax benefit wouldn't be expected to be realized for quite a while, and could be at cap gains, rather than ordinary income rates.

Nevertheless, when I present the issue to my client, he might want to consider such an option.

Does anyone think there might be a problem along the lines of the depreciation "allowed or allowable" rule?

The error was a simple math error, not related to depreciation, or any other deduction that could possibly impact more than one year.

Thanks in advance for your thoughts.

In either situation, I would give the client a complete rundown of the possible fixes and allow them to make that decision. The key thing is to give your client all the information necessary to make an informed decision.

I don't see a preparer penalty being raised on 1/2 of the potential audit issue (the deficiency half). Statute permits it, but it's just bizarre and serves no compliance purpose.

Then I talked to Big Accountant, who had made the original error on the 2006 form 1120S, who said that if it were up to them, they wouldn't amend 2006, instead they would take the deduction on the 2007 return, but that it was up to me and Client to decide. So, that being the case, I felt my only option was to request that they amend the 2006 form 1120S.

I felt Big Accountant was being quite squirrelly - they could have talked directly to our mutual client and taken responsibility for potential bad outcomes if they didn't amend 2006, but instead passed the buck to me. Now if the amendments of the related forms 1040 become difficult, they can say they told me so!

Oh well, that's the way it goes.

Thanks again for all of your help.

I took over an equipment leasing tax shelter audit in 1986 and found the preparer, with an address near Grand Central Station in NY, screwed the pooch royally, not understanding the transaction at all and leaving sizeable income off one year not under audit. Client had his genius, himself and I sit down at this guy's swanky office. I laid out my points and his response was 'the statute will run in six months.' Since I could not win the case on the two earlier years without this correction, and since the item was far in excess of 25% of income, I mentioned this, to which he said, 'they won't catch it if you say nothing.' As my client and I left his office, I said 'that guy is dangerous.' "Sounds that way, David, but you should see his house on the Sound."

What I am getting at is that sometimes a three way meeting will make everyone reveal their motives.

Gosh, I kind of miss those "Tax Shelters" from the 80's, especially the colorful salespeople!

The client is extremely pleased - he's looking at the refunds as $100K that he didn't have invested in the stock market, but rather is getting the entire "investment" back plus interest!

Who knew how it would all play out?

To recap - my client has BIG ACCOUNTANT prepare audited financial statement and S corporation income tax returns.

My client's BIG ACCOUNTANT audit firm had made a six figure mathematical error on the 2006 return, overstating income by six figures, which was discovered by me, LITTLE ACCOUNTANT, who only prepares client's form 1040.

BIG ACCOUNTANT pressed for simply reducing 2007 income to correct the error.

With the support of all of this tax forum, I insisted on BIG ACCOUNTANT amending the darn 2006 tax return, which we did, and have received the appropriate refunds.

Well, guess, what - client's S 2007 form 1120S is now being audited, with a special focus on the area BIG ACCOUNTANT recommended "plugging" to correct their 2006 error!

So there you go. Aren't we glad that there's not a six figure 2007 bogus deduction taken to correct the 2006 error . . .

In summary, this forum has been such a gold mine for me.

I have to thank you all for your attention to my questions.

Coincidentally, I was at the library this past weekend and happened to run across a book called "The Smartest Guys in the Room" -- about the Enron mess. Last night, I was reading part where Arthur Andersen auditors decided that what they saw was problematic, but after all it was expedient and and could be interpreted within the detailed definition of the rules - therefore it can be accepted and passed.

"What is right is not always popular -- what is popular is not always right."

In the case in this discussion, I think that BIG ACCOUNTANT may have been skirting with the unethical, which is why I so appreciated the input on the forum so much to confirm my viewpoint - they had me a bit intimidated!

Or, BIG ACCOUNTANT may have been mistakenly looking at the issue more from a financial statement audit standpoint, under which materiality standards are way different than for tax returns of course.

Sounds like a fascinating book . . .

The book is fascinating.. would recommend it if you have time. I am about halfway through and so far the most astounding thing to me is the tremendous lack of professional skepticism on the part of almost all the auditors, accountants, investment bankers, analysts and corporate officers. Most everyone believed what they wanted to believe. The saddest part is the "coziness" between client and auditor, and that Arthur Andersen audit principals allowed themselves to be intimidated by the threat of losing the account and its large fees.

It made me a little embarrassed to be a CPA.

Plus I'm Catholic, and at the same time the complicity of the Catholic Bishops in the cover up of the criminal activity of parish priests was coming out in the news.

A double hit! But, being humiliated can be a character building experience.