Understanding Constructive Receipt of Income Is An Essential Part of Tax Preparer Education

December 20, 2011 by  Filed under: Taxes 

One of the situations where paid tax preparers often wish they could un-hear something is when clients state that payments they received in business are not income. Such comments always demand inquiry into the facts and circumstances about the money. This is a critical component of tax preparer ethics.

A recent case involving Maryland criminal defense attorney, Stanley Needleman, illustrates the importance of a person needing reasonable cause for tax reporting actions. Needleman pleaded guilty in federal court to tax evasion. He could have avoided this fate if he had revealed details about his business income payments to someone with tax preparer education.

At the heart of the matter is the billing structure Needleman had for his legal practice. He obtained from his clients up front “engagement fees” for his services. This is not the same as a customary “retainer fee” in the legal industry. Retainer fees are held for application to future billing for services. Any unused portions of these fees at the close of engagements are refunded to clients.

Some tax preparation questions of Needleman revealed facts about the engagement fees. They were not related to a specified amount of work and were non-refundable. Hence, because Needleman was not required to refund the money under any circumstances, it comprised taxable income. As a cash basis taxpayer, an individual like Needleman must report taxable income when constructively received.

According to the reports, Needleman received significant sums of money as cash payments. He stored these large amounts in a safe in the basement of his home. In addition to omitting the income from his tax return, he violated a federal law against structuring financial transactions. This occurs when someone intentionally acts to avoid bank deposits that require issuance of a Currency Transaction Report. That’s what Needleman did when he made various bank deposits over several years in amounts slightly under the $10,000 reporting limit.

In an attempt to avoid capture for breaking one law – tax evasion – he broke another law against structuring cash transactions. Needleman also consented to disbarment from the practice of law. He faces up to five years of imprisonment for the income tax evasion and up to ten years for structuring financial transactions.

The lesson for everyone in the tax preparation business is to stay clear of individuals with shady practices of receiving money that allegedly is not income. Especially because they might be engaged in even more illegal procedures. That’s a web of deceit leading to severe punishment for anyone involved.

IRS Circular 230 Disclosure

Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.

Fast Forward Academy is a leading publisher of education for paid tax preparers and tax professionals. Access to free questions for the tax preparer ethics is available on their website.

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