Letter 5105 Being Sent to Select Return Preparers in January – How Can You Respond?

As a tax controversy attorney, although I don’t prepare returns myself, I try and stay in touch with issues affecting return preparers, CPAs, and enrolled agents.  The system depends on these folks to work.  In the past, if the IRS has thought that a particular preparer was routinely making mistakes, it could result in the IRS starting a return preparer project (RPP) whereby the IRS audits a large number of the preparer’s clients.  It could also result in the assertion of penalties against the preparer, a permanent ban or injunction sought in district court against the preparer, or even criminal charges.  I have experience in handling all of these types of cases.

Recently, however, I have heard reports of a less formal method being employed by the IRS – the soft letter.  Sometimes, this can be accompanied by a visit.  The letter at issue is “Letter 5105.”  When the IRS issues this letter and requests a visit, there isn’t necessarily an examination of any particular returns or any investigation against the preparer yet.  YET.  “Yet” is the key word.  If the IRS doesn’t like how you respond to the letter or to the visit, you better believe any thing you say can and will be held against you.  So, it is important, as always, to take any such visit seriously.

One question that arises is what rights you have when you get this letter.  Well, without an official determination, not any appeal rights.  However, without any examination, investigation, or active court case, the IRS doesn’t really have any rights to compel you to speak or to meet with them, either.  That isn’t to say the IRS should just be ignored – in some  cases it may be to your benefit to explain any discrepancies before a full blown investigation starts.  In others, you may want to talk with an attorney before you decide to volunteer information to the IRS.

The full text of an IRS Letter 5105 is below:

We reviewed tax returns you prepared in the past year and found that many have a high percentage of traits we believe typically indicate errors on Form 1040, Schedule C, Profit or Loss from Business (Sole Proprietorship). This letter reminds you of your responsibilities in this area and provides educational assistance. As a paid preparer, you are responsible for ensuring your clients’ returns are accurate. We ask that you pay special attention to these schedules next filing season.

Due diligence responsibilities
A paid tax return preparer must take multiple steps to prepare accurate tax returns on behalf of clients. These steps are a preparer’s due diligence and include reviewing the applicable tax law to establish the relevance and reasonableness of income, credits, expenses, and deductions on a return. In general, you can rely in good faith without verification on information your client provides. However, you can’t ignore the implication of the information you have. You must make reasonable inquiries if the information appears to be incorrect, inconsistent or incomplete.

Schedule C reminders
To prepare an accurate Schedule C, you must ask your clients relevant and probing questions to help you determine if the expenses are allowable. Taxpayers may not fully understand the tax laws and may incorrectly believe they can claim deductions for non-qualifying expenses. You should also ask your clients if they have receipts to support the expenses and instruct them to keep them in case we request supporting documentation.

Helpful resources
We provide information about the Schedule C on our website at www.irs.gov, keyword: Recommended Reading for Small Businesses. In addition, we recommend you review: 

• Schedule C instructions
• Circular 230, Section 10.22, Diligence as to accuracy
• Circular 230, Section 10.34, Standards with respect to tax returns and documents, affidavits, and other papers

Potential consequences
In the future, both you and your clients could face negative consequences from inaccurate returns. We’ll be looking for improvement in future returns you prepare. Inaccurate returns may result in any of the following consequences:

• If we examine your clients’ returns and find inaccuracies, your clients may be liable for additional tax, interest, additions to tax, and penalties.
• If you prepare a client return that has an understatement of tax liability due to an unreasonable position, we can assess you a minimum penalty of $1,000 per return (IRC Section 6694(a)).
• If you prepare a client return that has an understatement of tax liability due to reckless or intentional disregard   of rules or regulations by the tax preparer, we can assess a minimum penalty of $5,000 per return (IRC section 6694(b)).

I hope this letter has increased your awareness of your responsibilities as a paid tax return preparer and provided you with information on preparing accurate Schedules C for your clients.

Thank you for your attention to this matter.