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"w..- yw«...._ ‘ c . ‘32:?“ '.__. «.,. m.-- -.___ ._ . .1::.‘:3«.::::Lt':x:$-?,..§ .. w --. WM...“ ~ nfit..." ~ - “um"..- . -... ‘ ';:?.:'::;::.::...: ‘5—- . va—‘hdl L. w- .- ME ‘¥.§'§L,::‘T:....... w -. (233.. ”c...“- 'i' ‘ . up. r-u ~t—.-_n.. u.“ .1 ,4... “ ~. . «.3. .. $71133 v .: .As \. . ., N L. a." . u. ,. $32-3“ an: 7.. $5., ‘ v“ x»:...;; Q. “mm-fl .wau~.. . 3 . .. . ..s_:~'.3uL»25 15 §,Z Total 929 199 £§D§l-EL-Ag§ _N_ 3 21-30 67 29.8 31-40 104 46.2 41-50 37 16.4 >50 __11 .115 Total 299 199 E 1 E E 't' _N_ Owner or 77 Partner Manager 115 Senior _;2 Total 299 Pane; D. Edugarign _N_ Bachelors 133 Masters 82 Doctorate Q Total 93; Panel E, Sex _N_ Male 179 Female 46 Total 999 q o mkv IEE 65 Participants familiarity with guidance regarding practitioner responsibilities varied considerably. For example, while 9% regularly consider AICPA Statement on Responsibilities in Tax Practice No. 1 in their practice, 11% of the participants have never read it (Table 4.6, Panel A). Similarly, while 8% of the respondents stated they regularly consider Circular 230 in practice, 23% responded that they have never read it (Panel B). A similar distribution exists for familiarity with Internal Revenue Notice 90-20. 66 Table 4.6 FAMILIARITY WITH PRACTITIONER GUIDANCE Panel A Panel B Panel C . AICPA Treasury IRS Notice Frequency SRTP #1 Circular 230 90-20 N % N % N % Never Read 25 11.1 51 22.7 52 23.1 Reviewed Once 84 37.3 77 34.2 91 40.4 Reviewed More 95 42.2 80 35.6 65 28.9 Than Once, But Not Often Regularly Used 21 9.3 17 7.6 17 7.6 in Practice Total 225 100 225 100 225 100 67 Diversity was also evident in participant experience with penalties. When asked about the frequency with which the practitioner engaged in discussions with clients involving the substantial understatement penalty, 45.3% responded that such discussions occurred with some regularity (at least 4 times a year), 47.6% responded that they occurred somewhat less frequently (1 to 3 times per year), and 7.1% stated that they never participated in such discussions (Table 4.7). The results for the follow-up question addressing discussions with other practitioners indicates that these discussions occur with less frequency than client discussions. However, considerable diversity still exists. This diversity all but disappeared, however, when asked how often the participant, or the participant's office, had been assessed a penalty for violating the realistic possibility (or reasonable basis) standard. At least 87% stated that neither they nor their office had ever been assessed a penalty. 68 Table 4.7 PENALTY EXPERIENCE Frequency Per Year 1 to 3 4 to 8 > 8 Never times times times Total Client Discussions 16 107 72 30 225 Involving (7.1)5 (47.6) (32.0) (13.3) (100) Substantial Understatement Penalty Practitioner 50 97 56 22 225 Discussions (22.2) (43.1) (24.9) (9.8) (100) Involving Substantial Understatement Penalty Willingness to 81 123 17 3 224 Assume Positions (36.2) (54.9) (7.6) (1.3) (100) Possibly Leading to a Penalty Returns for Clients 155 55 7 4 221 Who Have Been (70.1) (24.9) (3.2) (1.8) (100) Assessed a Substantial Understatement Penalty Office Penalties 169 23 1 0 193 for Lacking (87.6) (11.9) (0.5) (0) (100) Realistic Possibility or Reasonable Basis Respondent 221 4 0 0 225 Penalties for (98.2) (1.8) (0) (0) (100) Lacking Realistic Possibility or Reasonable Basis 5Number of Responses (Percentage of Total Responses) 69 Perhaps the most insightful response involves the frequency with which respondents are willing to adopt positions that could lead to a penalty if audited. Although 36.2% stated they would never be willing to adopt such positions, a minority (8.9%) were willing to take such positions at least 4 times annuallyu Over 54% of the respondents were willing to take the risk from 1‘to three times per year. Thus it appears that although a relatively aggressive minority of practitioners exists, the majority are willing to incur the risk at least occasionally. In summary, respondent demographic characteristics offer no evidence of a self-selection bias. In contrast, the data indicate that participants possess considerable diversity in experience with tax practice, penalties, and practitioner guidance. As will be seen later, this diversity contributes extensively towards explaining practitioner behavior. 4.3 Statistical Procedures and Hypothesis Testing Data analysis proceeded in three steps. First, confirmatory factor analysis was used to estimate two directly unmeasured variables: practitioner non-conformity and neutralization. Second, both forward and backward stepwise analysis were employed to identify the optimal decision model. Additional variables considered include firm affiliation, professional position, years of tax experience, education, age, gender, familiarity with practitioner guidance, client importance 70 (both measured and manipulated), penalty experience, and experience with similar tax situations. Finally, the resultant optimal equation was used to investigate each hypothesis. Analysis of each hypothesis proceeded as follows. The first hypothesis predicted that as the severity of sanctions supporting the practitioner’s duty to the client increased, practitioner non-conformity, defined as supporting or recommending undisclosed positions lacking substantial support, would also increase. Testing this hypothesis required (1). identifying the optimal estimation of practitioner non-conformity, and (2) investigating the relation between sanctions supporting the duty to the client (both interpersonal and self-imposed) and the dependent variable practitioner non-conformity. Significantly negative relations, assessed via t-statistic, are consistent with the hypothesis. The second hypothesis investigates a de minimis requirement for neutralization strategies to result in a threshold effect. That is, unless the use of neutralization strategies is significantly negatively related to practitioner non- conformity, then use of these strategies cannot contribute to non-conforming behavior. In order to test this hypothesis, however, neutralization strategy usage, an unmeasured variable, must be estimated via factor analysis. Similar to the prior hypothesis, the significance of the relation between neutralization and practitioner non-conformity is assessed via 71 t-statistic. Hypothesis three seeks to eliminate the possibility of incorrect causal ordering. .Although it is not possible to prove a causal ordering, it is possible (and necessary) to eliminate the most plausible alternatives. If a correct ordering has been posited above, then controlling for prior behavior should have no effect on the use of neutralization strategies or their relation with practitioner non-conformity. The fourth hypothesis tests the theoretical proposition that only those practitioners who intensely perceive their obligation to the tax system use neutralization strategies. Testing this hypothesis requires two steps. First, the significance of a neutralization by self-imposed sanction supporting the tax system interaction variable is tested via t-statistic. If the relation is significant, the respondent sample is divided into two subsamples. The first subsample includes respondents who do not perceive a strong obligation to the tax system. The second subsample includes respondents who do perceive a strong obligation to the tax system. The relation between neutralization and practitioner non- conformity is then investigated in both subsamples. The theoretical proposition suggests that neutralization is significantly related to practitioner non-conformity in the second subsample only. Hypothesis five seeks to investigate the possibility of a relation between client importance, as measured by client 72 fees, and non-conforming behavior. If the model developed is accurate, then client fees are significantly positively related to practitioner non-conformity. As with the prior hypotheses, significance is determined via t-statistic. Chapter Five ANALYSIS OF RESULTS Chapter five reviews and analyzes the results of the statistical procedures employed in this study. The chapter consists of three sections. Section one presents and summarizes the results of factor analysis on two variables: practitioner non-conformity and neutralization. In the second section results obtained during hypothesis testing are presented and summarized. Section three discusses the implications of all regression model results on the practitioner’s decision model and the questions posed at the outset of this research. 5.1 Factor Analysis Confirmatory factor analysis ‘was used. to estimate two variables: practitioner non-conformity and neutralization. Eight decision variables were used in an effort to estimate practitioner non-conformity (Table 4.4). After eliminating items that did not satisfy standards of internal consistency or parallelism, three items remained. Further difficulties with measurement error forced a subsequent reduction to one item. ‘This item, "Continuing the engagement would not violate 73 74 my ethical standards," was used as the measure of practitioner non-conformity for all subsequent analyses.‘ Of the fourteen items devised to estimate the use of neutralization strategies (Table 4.2) , six, representing three neutralization strategies, remained (Table 5.1). Thus, responding practitioners demonstrated a preference for three neutralization strategies: denial of responsibility, defense of necessity, and appeal to higher loyalties. In contrast, Hite (1989) obtained evidence suggesting two strategies (metaphor of the ledger and denial of responsibility) were of preeminent importance to taxpayers. This difference may be attributable to different sample populations (taxpayer vs. practitioner behavior). The lack of theoretical guidance, however, reduces further interpretation to conjecture. ‘Descriptive statistics for all variables are in Appendix C. 75 Table 5.1 NEUTRALIZATION FACTOR LOADINGS Strategy Measure Loading Denial of Where tax law is uncertain, the .3813 Responsibility recommended position should favor the client. Ultimately, it is the taxpayer's .4714 responsibility to adopt positions on the return. Defense of If the practitioner does not .3932 Necessity assist the client, the client may pay too much (or too little) in taxes. My office needs our continuing .3640 clients. Appeal to The practitioner's obligation to .4427 Higher the client takes priority over Loyalties IRS preferences. The role of the practitioner .3865 includes more than just supporting the voluntary compliance system. 76 5.2 Tests of Hypotheses The regression model used to investigate hypotheses one and two (Model 1) can be found in Table 5.2. This model includes all practitioner decision model variables (as depicted in Figure 1) plus experience with similar tax situations (EXP), client importance (IMP), penalty experience (PEN), and practitioner education (EDUC).2 All other demographic variables (respondent's age, firm affiliation, professional position, gender, and familiarity with practitioner guidance) were not significantly associated with practitioner non- conformity. 2Appendix B summarizes the variables used in this chapter. 77 Table 5.2 REGRESSION MODELS Model 1 Coefficient Variable bi B, t 8, 1.5012 2.03“ 38 -0.2287 -0.2647 1.66‘ cs -0.0056 -0.0063 0.04 so 0.1760 0.1622 0.83 so -0.0751 0.0780 0.36 n 0.3401 0.6585 2.84” SSN -0.0759 -O.5128 2.17” EXP 0.4629 0.2311 2.72” IMP 0.4688 0.2076 2.50” PEN 0.2516 0.2394 2.83“ EDUC -0.2762 -0.1562 1.91‘ P -0.0026 -0.0021 0.02 Adjusted R2 = 0.1982 F(p<) = 5.599 (0.0000) Model 2 Coefficient Variable bi B, t 60 1.6934 2.95” 83 -0.218 -0.2522 3.15” N 0.3294 0.6378 2.83“ _SSN -0.0691 -0.5019 2.18” EXP 0.4942 0.2467 3.03“ IMP 0.5404 0.2393 2.98” PEN 0.2472 0.2351 2.86“ EDUC -0.2616 -0.1479 1.86° Adjusted Rz==0.2094 F(p<) = 8.152 (0.0000) significant at .05 significant at .10 78 As is apparent from the relevant t-statistics, neither interpersonal (GC) nor self-imposed (SC) sanctions supporting the client are significantly associated with practitioner non- conformity. Thus, no support exists for hypothesis one. Interpersonal and self-imposed sanctions supporting the client do not encourage the practitioner to violate the duty to the tax system. Neutralization (N), self-imposed sanctions supporting the tax system (SS), and the interaction between neutralization and self-imposed sanctions supporting the practitioner’s duty to the tax system (SSN) , however, are significantly associated with practitioner non-conformity. Thus, hypothesis two, which predicts a positive association between neutralization and practitioner non-conformity, is supported. .As discussed in Chapter 3, the existence of a significantly positive association between neutralization and practitioner non-conformity raises the possibility that neutralization strategies may lead to a penalty threshold effect. Identification of a threshold's existence, however, requires comparing the total effect of sanctions supporting the client versus the total effect of sanctions supporting the tax system. This comparison is discussed below in conjunction with regression model 2. Model 2 (Table 5.2) displays the resulting re-estimation of model 1 after eliminating variables not significantly associated with practitioner non-conformity. In addition to 79 the neutralization, self-imposed sanction, and interaction terms, several other variables remain significantly associated with practitioner non-conformity. These variables include situation specific experience (EXP), client importance (IMP), penalty experience (PEN), and respondent education (EDUC). All four terms are measured variables. Note, specifically, that client importance does not represent client fees. As shown in Model 4 (Table 5.3), no support exists for a positive association between fees and practitioner non-conformity. Thus, hypothesis 5 is not supported, In model 2, three of the four additional variables are positively associated with practitioner non-conformity (EXP, IMP, and PEN). One variable (EDUC) is negatively associated with the dependent variable. Summing the standardized coefficients found in Model 2 indicates that the total effect of variables supporting the client exceeds the total effect of variables supporting the tax system. Thus, support is found for the existence of a penalty threshold effect. 80 Table 5.3 REGRESSION MODELS Model 3 Coefficient Variable bi B, t 80 1.8579 3.45" ss -0.2063 -0.1948 2.60“ N 0.2794 0.4416 2.09” SSN -0.0661 -0.3919 1.80” EXP 0.6664 0.2716 3.56“ IMP 0.5377 0.1944 2.53“ in“... Adjusted R2 = 0.1560 F(p<) = 6.547 (0.0000) Model 4 - Coefficient Variable hi 6, t 30 1.6641 2.75“ ss -0.2172 -0.2027 3.12” N 0.3294 0.5142 2.82” SSN -0.069 —0.4043 2.17“ EXP 0.4938 0.1988 3.02” IMP 0.5341 0.1907 2.87” PEN 0.2469 0.1893 2.84“ EDUC -0.2662 -0.1195 1.86’ FEE 0.0258 0.0104 0.16 Adjusted R2 = 0.2094 F(p<) = 8.152 (0.0000) significant at .05 significant at .10 81 The possibility of an incorrect causal ordering (H3) is assessed in Model 3 (Table 5.3). This model represents the re-estimation of model 2 after eliminating from the sample those respondents who admitted to at least one personal or office penalty assessment. As can be seen by viewing the t- statistics for N in both models, neutralization remains significantly positively associated with practitioner non- conformity. Thus, hypothesis three is supported and neutralization does not appear to be spuriously related to practitioner non-conformity. Models five and six (Table 5.4) address the differing use of neutralization strategies by practitioners. Based on the respondent's self-imposed sanction supporting the tax system (SS), the participant sample‘was further divided into two sub- samples. Model five is the estimated regression equation for respondents with relatively low self-imposed sanctions supporting the tax system ("Unimportant" or "Very Unimportant") . Model six is based on respondents with relatively high self-imposed sanctions supporting the tax system ("Important" or "Very Important"). Respondents who marked "Neutral" on the five point Likert scale meaSuring the sanction were not included in these tests. 82 Table 5.4 REGRESSION MODELS - DIVIDED SAMPLE Model 5 Coefficient Variable bi B, t 3, 0.9565 0.62 LSS —0.2091 -0.0773 . 0.44 N 0.2285 0.3658 2.33” EXP 0.5033 0.2026 1.17 IMP 0.4419 0.1578 0.85 PEN 0.3302 0.2532 1.63 EDUC 0.0180 0.0082 0.05 Adjusted R2==0.1412 F(p<) = 3.433 (0.0080) N = 84 Model 6 Coefficient Variable bi B, t 8,, 2.588 2.45” HSS -O.4844 -0.1844 2.38” N -0.0032 -0.0050 0.06 EXP 0.5872 0.2364 2.95" IMP 0.5794 0.2069 2.62” PEN 0.3195 0.2451 2.98“ EDUC -0.3779 -0.1723 2.16” deui§§d R2==0.1717 F(p<) = 5.808 (0.0001) significant at .05 significant at .10 83 Of particular interest in these regression models is the significance of neutralization. Specifically, although neutralization is significantly associated with practitioner non-conformity for respondents who considered the self-imposed sanction unimportant, it is not significantly associated for respondents who considered the sanction important. This directly contradicts hypothesis four, which predicted neutralization strategies would be used by those practitioners who strongly perceive their obligation to support the tax system. 5.3 Model Evaluation Figure 2 displays the original practitioner's decision model and observed correlation coefficients.’ Comparing the observed correlation coefficients with the predicted relations found in Figure 1 results in only mixed support for the decision model. Specifically, while all but one correlation is of the correct sign, only seven correlations are significantly different from zero. 3A table of simple correlations for all measured and manipulated variables can be found in Appendix A. 84 Figure 2 DECISION MODEL CORRELATION COEFFICIENTS significant at .05 significant at .10 Where: GS = Interpersonal Sanctions Supporting the Tax System $8 = Self-Imposed Sanctions Supporting the Tax System CC = Interpersonal Sanctions Supporting the Client SC = Self-Imposed Sanctions Supporting the Client P = Enacted Penalties N = Neutralization SSN = Interaction between SS and N PNC = Practitioner Non-Conformity 85 The results evident in Tables 5.2 through 5.4 also offer only mixed support for the practitioner's decision model developed above. Consistent with this model is the negative association between practitioner non-conformity (PNC) and self-imposed sanctions supporting the tax system, and the positive association between practitioner non-conformity and neutralization. Evidence inconsistent with the decision model includes an insignificant association between interpersonal and self-imposed sanctions supporting the client and the dependent variable, and a similarly insignificant association between enacted sanctions and PNC. Perhaps the most puzzling result, however, is the interaction between neutralization and self-imposed sanctions supporting the tax system. Although the existence of an interactive effect is consistent with Minor's (1981) development of neutralization theory, the results found in Table 5.4 do not support the proposition that only those who strongly perceive an obligation to comply with the system will have a need to neutralize. In contrast, the results suggest that neutralization is irrelevant to those who perceive the greatest obligation to the tax system. One possible explanation, first raised by Thurman et al. (1984), is the existence of a learning effect (i.e., neutralization may be a learned skill). With regard to taxpayers, Thurman et al. argued that the relative infrequency with which taxpayers complete their tax returns suggests a 86 lack of skill in using neutralization strategies, thereby contributing to a lack of an observed interaction between neutralization and self-imposed sanctions. Practitioners, in contrast, confront their obligation to the tax system with considerably greater frequency. As a result, practitioners are so adept at using neutralization strategies that the strategies are already internalized, thereby offsetting any perceived obligation to support the tax system. This explanation, however, is inconsistent with Hite (1989), who found a stronger association between neutralization and anticipated behavior for inexperienced neutralization users (taxpayers) who perceived a lower obligation to the system. Obtained results also suggest that neither client fees nor enacted sanctions (at least for the ranges of fees and sanctions tested here) influence practitioner behavior. This conclusion, however, must be interpreted with caution since precisely the same result would be expected for an ineffective manipulation. Evidence supporting this latter point can be found in the questions asked respondents in the final section of the instrument. In the final section, questions were asked specifically to ascertain the effectiveness of manipulations in the instrument. Two questions in particular inquired "[d]id you consider the potential Internal Revenue Code penalty severe or mild?" and "[aJssuming the case was real, would [the client] be an important client to your firm?" The correlation 87 coefficient between the responses to the first question and the manipulated penalty is .1086. The correlation coefficient between the second response and client fee is -.1147. Both clearly suggest manipulations were ineffective. Finally, further insight can be gleaned from a comment made by a participant confronted with the threat of a moderate penalty. This particular respondent stated that he did not feel the enacted penalty to be as threatening as the possibility of being placed on the IRS's "watch list.” Several other conclusions from these tests can be drawn by considering the standardized regression coefficients in regression model 2 (Table 5.3) . For each variable the coefficient is quite small, and in conjunction with the small R2 statistic (Adjusted R2 = .2094) they strongly suggest other factors (outside the scope of this study) impact practitioner decisions. However, accepting this as indisputable, several other observations are pertinent. First, the standardized, regression. coefficient for neutralization (N) is :more than. twice the size of the coefficient for the practitioner's duty to the tax system (SS) (Table 5.2, Model 2). Given the insignificance of enacted sanctions, this suggests the possibility of a threshold effect stemming from neutralization. Second, client importance (IMP), practitioner situation specific experience (EXP), and penalty experience (PEN) are similarly positively associated with non-conformity, and possess far greater effect than the 88 negatively associated educational effect (EDUC). This furthers supports the existence of a threshold effect. Together, these observations suggest that the practitioner's obligation to support the tax system (consistently espoused by the IRS), is not extremely constraining on the practitioner. A final intriguing result concerns the significant positive association between penalty experience and practitioner non- conformity. Taken to the extreme, this suggests that the more experienced the practitioner becomes with threatened penalties (both taxpayer and preparer), the more aggressive (s)he becomes. Although this result is consistent with Chang and Schultz (1989), we must first concede that enacted sanctions are ineffectual, otherwise such a conclusion in counterintuitive. Chapter 6 CONCLUSIONS The evidence obtained in this dissertation supports the existence of thresholds in penalty effectiveness. These thresholds result, at least in part, from the use of neutralization strategies. Evidence also suggests that neutralization strategies may facilitate the reconciliation of conflicting practitioner norms, although a direct measure of the practitioner's obligation to assist the client was not found. The existence of an interaction between neutralization and self-imposed sanctions is also supported. However, it is unclear whether neutralization is most useful to practitioners who feel less obligated to the tax system or if neutralization was internalized prior to measuring self-imposed sanction supporting the tax system. Evidence is not found supporting the importance of fees or legal sanctions. Finally, the evidence most strongly supports the conclusion that other unidentified variables also impact the practitioner's decision not to conform. Every research endeavor, especially those that seek to explore largely undiscovered areas of knowledge, suffers from limitations. This study is no exception. One such limitation follows from the simplified relation assumed to exist between the taxpayer and practitioner. Most importantly, the relation allowed in this study does not permit personal interactions. 89 90 Thus, generalizations of obtained results to actual client/practitioner relations are tentative at best. Another limitation stems from the sample of practitioners participating in this study. In an effort to increase the response rate, direct contact with practitioners was selected over an anonymous mailing. Unfortunately, this resulted in a sample of participants heavily biased towards the "big 6” CPA firms. Whether these results are generalizable to a more representative sample of practitioners is unknown. Finally, the existence of a non-response bias cannot be ruled out. However, demographic data shows no clear bias in the participant sample. The true value of a research study may be in its ability to raise more questions than answers. In this respect, the current work is quite successful. Unanswered questions include, for example, the validity of the decision model derived herein. While several relations predicted by the model were not confirmed, it is eminently possible that these results may be due to inadequate measures. The decision model was derived from deterrence and neutralization theories. Both theories have been supported in other, occasionally conflicting, research. Thus, further research into this decision model must be pursued. Additional unanswered questions include the precise meaning of "client importance." It can be concluded from this research that it is, at least partially, measured by client 91 fees. But, other aspects of importance should be explored. For example, is importance relative to the practitioner? What role does the identity of the client (corporate, individual, or other) play? Does importance depend on the practitioner's perception of the client’s need for professional assistance? The role of penalty experience in practitioner decisions is also puzzling. The positive association between penalty experience and practitioner non-conformity suggests familiarity breeds indifference, or even aggressiveness. The counter-intuitive nature of this result demands corroboration. Finally, the observed interaction between neutralization and self-imposed sanctions supporting the tax system counters theoretical expectations. Although the possibility of a learning effect is plausible, replication is necessary to verify this explanation. Interestingly, Hite (1989) obtained similar results with.a:respondent sample*where such a learning effect is improbable (i.e., taxpayers). To conclude, the increasing IRS attempts to improve practitioner compliance with IRS objectives represent a dramatic shift from earlier years. The consequences of these attempts must be determined if we are to understand the behavior of practitioners, and the environment within which they operate. APPENDICES 92 Appendix A SIMPLE CORRELATIONS 631 052 L50 GCl (:02 1.00 .861 1.00 l .043 .041 1.00 .045 .026 .911 1.00 I .072 .155 .829 .842 1.00 -.054 -.027 -.075 -.065 -.115 I -.123 -.156 .011 -.002 -»076 -.217 -.187 .010 .031 .024 -.046 -.040 .052 .098 .026 -.033 -.071 .025 .015 -.058 -.043 -.043 .117 .086 .080 -.034 -.058 .054 .044 -.002 I P FEE PEN EXP IMP EDUC SSN , P 1.00 ’ FEE .052 1.00 PEN .040 .034 1.00 EXP -.159 .060 .103 1.00 IMP -.030 .232 .024 .049 1.00 EDUC .037 .044 .042 .117 .004 1.00 SSN -.061._-.018 .139 .053 .119 .085 91.00“ lSee Variable Summary (Appendix B). 93 Appendix B VARIABLE SUMMARY Instr. Var. Description Def. Ref. PNC Practitioner Non-Conformity Ms1 V,82 N Neutralization F3 III,7- 20 SS Self-Imposed Sanction Supporting Ms4 III,3 the Tax System LSS Low Self-Imposed Sanction Supporting Ms‘ III,3 the Tax System HSS High Self-Imposed Sanction Ms’ III,3 Supporting the Tax System GSl Interpersonal Sanction Supporting Ms4 III,1 the Tax System G82 Interpersonal Sanction Supporting Ms‘ III,2 the Tax System (alternate) SC Self-Imposed Sanction Supporting Ms4 III,6 the Client GC1 Interpersonal Sanction Supporting Ms‘ III,4 the Client GC2 Interpersonal Sanction Supporting Ms4 III,5 the Client (alternate) P Enacted Penalty Mp6 V FEE Client Paid Fee Mp6 V 94 Appendix B VARIABLE SUMMARY (cont'd) Instr. Var. Description Def. Ref. PEN Penalty Experience Ms“‘ IV,3&4 EXP Situation Specific Experience Ms‘ VI,5 IMP Client Importance Ms‘ VI,6 EDUC Respondent Education Ms‘ IV,15 SSN Interaction Between N and SS ‘ ‘Measured variable (Ms). See Chapter 5, Section 1. 2Instrument Section, Item Number (See Appendix D). 3Factor variable (F) measured by factor scores. See Chapters 4 and 5. ‘Measured variable (Ms). See Chapter 4, Section 1. ’Variable extracted from $8. See Chapter 5, Section 2. 6Manipulated variable (Mp). See Chapter 4, Section 1. 7Represents the sum of Items 3 and 4, Instrument Section 5. 8Represents the product of SS and N. 96 Appendix C DESCRIPTIVE STATISTICS 95% Confidence Interval Var. Mean Std. Dev. Lower Upper PNC 2.971 1.240 2.802 3.140 N 0.000 1.936 -0.256 0.256 SS 3.586 1.157 3.433 3.739 LSS 1.711 0.458 1.573 1.849 HSS 4.362 0.482 4.281 4.444 GSl 3.611 1.117 3.463 3.759 G82 3.399 1.065 3.257 3.541 SC 4.427 0.921 4.305 4.550 GC1 4.395 0.943 4.270 4.521 GC2 4.227 0.899 4.106 4.347 P 2.031 0.826 1.923 2.140 FEE 1.524 0.500 1.459 1.590 PEN 3.114 0.951 2.987 3.240 EXP 1.455 0.499 1.387, 1.523 IMP 1.734 0.443 1.674 1.795 EDUC 1.439 0.565 1.365 1.514 SSN 0.058 7.265 -1.024 0.907 97 Appendix D SURVEY INSTRUMENT The Conflict in Practitioner Responsibilities : A Research Study Conducted by Geoffrey J. Gurka Ph.D. Student Michigan State University Graduate School of Business Administration Department of Accounting Eppley Center East Lansing, MI 48824-1121 All responses to this questionnaire will be kept strictly confidential and anonymous. Should you have any questions about the survey, please call: (517) 355-7486 98 Appendix D (cont'd) The Conflict in Practitioner Responsibilities: A Research Study Dear Practitioner: Before enactment of the 1989 Omnibus Budget Reconciliation Act the Treasury interpreted.a practitioner's obligation to support the voluntary compliance system as requiring practitioner verification that all adopted undisclosed tax return positions possess "substantial authority." Practitioners, however, also possess a responsibility to assist the client. This responsibility, as interpreted by the AICPA, only requires a "realistic possibility of success" for undisclosed return positions. The duality in practitioner standards raised the possibility of a conflict between the practitioner’s obligation to the system versus his responsibility to the client. In 1989, the Omnibus Budget Reconciliation Act substantially revised practitioner responsibilities in the voluntary compliance system. Consistent with the standards of the accounting profession, tax law now requires practitioners to verify that adopted undisclosed return positions possess a "realistic possibility of success" (section 6694(a)). However, rgxpgygrg are still required to disclose all positions not satisfying the "substantial authority" standard. This research investigates the tradeoff between practitioner responsibilities to the client and to the tax system. The instrument enclosed consists of five sections. The first section provides a brief summary of the four practitioner accuracy-related comfort levels currently under debate. Sections two and three assess your role in this conflict and tax experience. Section four presents a hypothetical case involving the deductibility of entertainment expenses. Assume you are the preparer in this case. Information is also provided regarding relevant tax authorities. The client and tax authority information in this section is necessarily brief, and is not intended to mislead. After this, questions are asked based on the case. The questi gas have no pregetemiggg answer. In addition, you are encouraged to refer to the case as needed. The final section assesses the completeness and clarity of the client information. 99 Appendix D (cont'd) All information obtained will be strictly ggrfiigenriai and grgnymggg. Results will be presented only in summary form. The information requested in part two is intended to provide a basis for comparison between groups of respondents. Only partners/owners, managers, or seniors who are frequently involved in client tax matters should respond to this survey. By completing and returning this questionnaire you indicate your voluntary agreement to participate in this study. You will need an estimated 30 to 45 minutes to complete this task. If possible, please complete and return by December 15, 1990. Thank you for your assistance. Sincerely, Geoffrey J. Gurka Michigan State University 100 Appendix D (cont'd) Practitioner Accuracy-Related Standards Recent discussion concerning practitioner support for the voluntary compliance system has focused on four accuracy- related assurance levels: a e s s The 1989 Omnibus. Budget. Reconciliation..Act. repealed. the practitioner's "reasonable basis," or negligence, standard of former IRC section 6694 (a) (understatement of a taxpayer's liability by a return preparer due to negligent disregard of rules and regulations). That standard required prudent and reasonable conduct from a practitioner and was more easily met than the three standards discussed below. Violation of the ”reasonable basis” standard, if penalized, resulted in a $100 penalty. Dissatisfaction with the effectiveness of the reasonable basis standard in promoting the practitioner's duty to support the voluntary compliance system led the Treasury to advocate a new, stricter standard. In proposed revisions to Circular 230 (Treasury Department's Proposed Modification of Regulations Governing Practice before Internal Revenue Service 1986), the Treasury argued that the standard had "eroded" in recent years resulting in taxpayer compliance problems. Hence, the Treasury advocated replacing "reasonable basis" with ”substantial authority." However, the 1989 act did not adopt the "substantial authority" standard. Instead, the "realistic possibility of success standard" was enacted. The "realistic possibility of success" standard became the standard of practitioner conduct with the enactment of new IRC section 6694(a) in 1989. As stated in the House Ways and Means Committee report, this standard was adopted "because it generally reflects the professional conduct standards applicable to lawyers and certified public accountants." Violation of this standard can result in a $250 practitioner penalty. While Congress did not provide a definition for this standard, the IRS has indicated a one-in-three likelihood of success will be considered a realistic possibility (Notice 90- 20) . This likelihood, however, is not established as the minimum acceptable. 101 Appendix D (cont'd) In contrast, the AICPA believes that the "realistic possibility" standard cannot be expressed in terms of percentage odds. Instead, it defines the "realistic possibility" standard as ”a good faith belief that the [tax return] position [being recommended] has a realistic possibility of being sustained..." (Statement on Responsibility in Tax Practice (1988 Rev.) No. 1). Whichever definition is applied, the new standard is considered stricter than the previous "reasonable basis" standard, but not as strict as either the "substantial authority" or "more likely than not" standards. t 't The taxpayer substantial understatement penalty (IRC Sec. 6662(b)(2)) establishes the "substantial authority" standard. This standard never applied to practitioner conduct, although it had been proposed. Instead, the "substantial authority" standard applies to the taxpayer for undisclosed positions adopted on the return by the taxpayer . Practitioners are free to recommend (and prepare) return positions that do not possess substantial support, unless, of course, the recommended position also fails the "realistic possibility" standard. The taxpayer penalty for not disclosing return positions lacking substantial authority is 20% of the amount of the substantial understatement. No definition exists for "substantial authority." Regulation section 1.6661-3(b)(1) states only that "[t]here is substantial authority for the tax treatment of an itemIonly if the weight of authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary positions." With regard to the other standards of conduct, however, Regulation section 1.6661- 3(a)(2) specifies that the standard is stricter than "reasonable basis," but not as strict as "more likely than not." The "more likely than not" standard represents the strictest standard advocated by the IRS to date (Executive Task Force for Internal Revenue Commissioner’s Penalty Study). This standard requires something more than a 50% likelihood of success. If enacted as proposed, violation would result in a $100 penalty. 102 Appendix D (cont’d) Responsibilities Data Use the following scale when responding to questions 1 through 6: Very Important . . . Somewhat Important . Neutral . . . . . . Somewhat Unimportant Very Unimportant . . eeeee eeeee eeeee eeeee eeeee eeeee eeeee eeeee o...- eeeee eeeee eeeee U'chUNl-t If you are uncertain of any response, please leave it blank. (CIRCLE ONE FOR EACH) Very Very Important Neutral Unimportant 1. How important does YOUR FIRM consider your responsibility to gnly adopt tax return positions for which you have at least SUBSTANTIAL AUTHORITY? . . . 1 2 3 4 5 2. How important do the FIVE PRACTITIONERS YOU KNOW BEST consider your responsibility to gnly adopt tax return positions for which you have at least SUBSTANTIAL AUTHORITY? . . . l 2 3 4 5 3. How important do YOU consider your responsibility to only adopt tax return positions for which you have at least SUBSTANTIAL AUTHORITY? . . . . . . l 2 3 4 5 103 Appendix D (cont’d) (CIRCLE ONE FOR EACH) Very Very Important Neutral Unimportant 4. How important does YOUR FIRM consider your responsibility to iny adopt tax return positions for which you have at least a REALISTIC POSSIBILITY OF SUCCESS? . . . . 1 2 3 4 5 5. How important do the FIVE PRACTITIONERS YOU KNOW BEST consider your responsibility to only adopt tax return positions for which you have at least a REALISTIC POSSIBILITY OF SUCCESS? . . . 1 2 3 4 5 6. How important do YOU consider your responsibility to only adopt tax return positions for which you have at least a REALISTIC POSSIBILITY OF SUCCESS? . . . 1 2 3 4 5 104 Appendix D (cont'd) While a taxpayer may be penalized for any adopted undisclosed tax return position lacking substantial authority, a practitioner will be penalized only if the position lacks a realistic possibility of success. Many reasons exist for a practitioner to recommend to a client an undisclosed tax return position lacking substantial authority, but possessing a realistic possibility of success. Using the following scale as a guide, circle the extent of your agreement or disagreement to each reason below: Strongly Disagree Somewhat Disagree Neutral . . . . . Somewhat Agree . Strongly Agree . CO... .0... .0... O. 0.... 0.... UlubUNH Statements 7 through 20 complete the following phrase: It is ethically acceptable for a practitioner to recommend to a client an undisclosed tax return position lacking substantial authority (but.possessing a realistic possibility of success) because... (CIRCLE ONE FOR EACH) Strongly Strongly Disagree Neutral Agree 7. Where tax law is uncertain, the recommended position should favor the client . . . 1 2 3 4 5 8. If the position is contested, clarification of the law will improve subsequent voluntary compliance . . . . . . 1 2 3 4 5 9. Taxpayers who only take "IRS approved" positions will overpay their taxes . . . . . 1 2 3 4 5 10. The practitioner works to improve compliance and therefore need not worry over one incident . . . . . . 1 2 3 4 5 105 Appendix D (cont'd) It is ethically acceptable for a practitioner to recommend to a client an undisclosed tax return position lacking substantial authority (but.possessing a realistic possibility of success) because... (CIRCLE ONE FOR EACH) Strongly Strongly Disagree Neutral Agree 11. If the practitioner does not assist the client, the client may pay too much (or too little) in taxes . . 1 2 3 4 5 12. Often the IRS ignores the practitioner's duty to assist the client . . . . . . 1 2 3 4 5 13. The practitioner's obligation to the client takes priority over IRS preferences . . . . . . . . . 1 2 3 4 5 14. Ultimately, it is the taxpayer's responsibility to adopt positions on the return . . . . . . . . . . . 1 2 3 4 5 15. By itself, a recommendation will not adversely affect voluntary compliance . . . . 1 2 3 4 5 106 Appendix D (cont'd) It is ethically acceptable for a practitioner to recommend to a client an undisclosed tax return position lacking substantial authority (but possessing a realistic possibility of success) because... (CIRCLE ONE FOR EACH) Strongly Strongly Disagree Neutral Agree 16. The unfairness of the tax system already hurts voluntary compliance . . . . 1 2 3 4 5 17. The IRS is primarily interested in maximizing revenues collected . . . . . 1 2 3 4 5 18. The role of a tax practitioner includes more than just supporting the voluntary compliance system . 1 2 3 4 5 19. My office needs our continuing clients . . . . . 1 2 3 4 5 20. In general, tax clients comply with tax laws . . . . 1 2 3 4 5 107 Appendix D (cont'd) Experience & Personal Data Use the following scale in answering questions 1 through 6: Never . . . . . . . . . . . . . . . . . . 1 Rarely (1 to 3 times a year) . . . . . . 2 Occasionally (4 to 8 times a year) . . . 3 Frequently (more than 8 times a year) . . 4 (CIRCLE ONE FOR EACH) Never Frequently 1. How often do you deal with client questions in which the possibility of a substantial understatement penalty (IRC Sec. 6662(b)(2)) is discussed with the CLIENT? . . . . . . . . . 1 2 3 4 2. How often do you deal with client questions in which the possibility of a substantial understatement penalty is discussed with another PRACTITIONER? . . . . . . . . . l 2 3 4 3. How often are you willing to take a position that you believe would lead to a substantial understatement penalty if audited? . . . . . . . . . 1 2 3 4 4. How often do YOU prepare returns for clients who have been nsgggggg a substantial understatement penalty? . . . . . . 1 2 3 4 5. How often has YOUR OFFICE been assessed a penalty for understating a client's tax liability by including in a return a position lacking a realistic possibility of success or reasonable basis (as under prior law)(IRC Sec. 6694(a))? . . L. N u p 108 Appendix D (cont'd) (CIRCLE ONE) Never Frequently 6. How often have YOU been assessed a penalty for understating a client's tax liability by including in a return a position lacking a realistic possibility of success or reasonable basis (as under prior law) (IRC Sec. 6694(a))? . . . . . . . . . . 1 2 3 4 Use the following scale definitions in answering the 7 through 9: Very Unfamiliar (never read it) . . . . . . . . . . . Unfamiliar (reviewed it once) . . . . . . . . . . . . Familiar (reviewed it more than once, but not often) Very Familiar (regularly consider it in practice) . . ecANIH (CIRCLE ONE FOR EACH) Very Very Unfamiliar Familiar 7. How familiar are you with AICPA Statement on Responsibilities in Tax Practice No. 1 (Tax Return Positions)? . . . . . . . . . . . . 1 2 3 4 8. How familiar are you with Treasury Circular 230 (Regulations Governing the Practice of Attorneys, Certified Public Accountants, Enrolled Agents and Enrolled Actuaries before the IRS)? . . . . . . . . . 1 2 3 4 9. How familiar are you with Internal Revenue Service Notice 90-20 (guidance pertaining to positions satisfying the "realistic possibility" standard)? . . . . . . . . . . . . 1 2 3 4 109 Appendix D (cont’d) 10. Are you: male . . . . . . . . . . . . . . . . female . . . . . . . . . . . . . . . 11. What is your age? 21 - 30 O O O O O O O O O O O O O O O 31 - 40 . . . . . . . . . . . . . . . over 6 o O O O O O O O O O O O O O O O 12. What is your professional position? Owner/Partner . . . . . . . . . . . . Manager . . . . . . . . . . . . . . . Senior . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . 'Please describe (if you circled "other"): (CIRCLE ONE) O O O 1 O O O 1 U'IhUN (CIRCLE ONE) . . . 1 . . . 2 . . . 3 4 110 Appendix D (cont’d) 13. What TYPE OF FIRM are you affiliated with? (CIRCLE ONE) "Big 6" CPA firm . . . . . . . . . . . . . . 1 Other National CPA firm . . . . . . . . . . . Regional CPA firm . . . . . . . . . . . . . . Local CPA firm . . . . . . . . . . . . . . . Self-employed . . . . . . . . . . . . . . . . GUI-OUR) Other . . . . . . . . . . . . . . . . . . . . 'Please describe (if you circled "other"): 14. How many years of TAX EXPERIENCE do you have? (Include only those years in which 25% or more of your time was devoted to taxpayer client matters.) (CIRCLE ONE) 1 - 3 years . . . . . . . . . . . . . . . . . 1 4 - 6 years . . . . . . . . . . . . . . . . . 7 - 10 years . . . . . . . . . . . . . . . . 11 - 16 years . . . . . . . . . . . . . . . . 17 - 24 years . . . . . . . . . . . 25 - 35 years . . . . . . . . . . . . . . . . qmmeuu over 3 5 years O O O O O O O O O O O O O O O O 111 Appendix D (cont'd) 15. What is your highest educational degree obtained? Bachelors (BA/BS/BSBA) Masters (MBA/MS/Macc) . Doctorate (Phd/DBA) . . Other . . . . . . . . . 'Please describe (if you (CIRCLE ONE) . . . . . . . . . . . 1 . . . . . . . . . . . 2 . . . . . . . . . . . 3 . . . . . . . . . . . 4‘ circled "other") 112 Appendix D (cont'd) Tax Case INEIBQQIIQNE Below you will find information concerning a corporate tax client- Please read.this.data carefully; It will provide you with material necessary to complete the remainder Of the instrument. After the client information you will find several questions based on the client data. Read each question carefully. Indicate your response on the scale immediately following the question. When answering the.questions assume that ygn are the corporation’s tax preparer. You are encouraged to refer back to the client information as needed. Panel World Inc., a closely held corporation owned by Thomas and Rose Buchanan, has been a client Of your firm for several years. Panel World manufactures and sells custom veneered plywood for use in kitchen cabinets, furniture, store fixtures, and other specific customized applications. Orders are filled according to customer specifications, thus a finished goods inventory is generally not maintained. Customers are typically wholesale distributors who in turn sell the product to cabinet shops, architects, etc. Because of the firm's customer base (e.g., wholesalers), Panel World has not previously advertised in trade journals or magazines. For similar reasons product prices have not proven stable, often fluctuating on a monthly basis. Marketing firm products has traditionally involved personal visits by sales personnel coupled with follow-up telephone solicitation. The cost Of such personal visits has never exceeded $48,000 in any given year. In an effort to spur sales Panel World adopted.a new'marketing technique recently employed with some success in a related industry. The technique involves inviting both regular and potential customer representatives to participate in a two-day weekend sales seminar Offered in conjunction with a major entertainment event. Customers who are willing to send two representatives to attend special seminars on both Saturday and Sunday morning are Offered free air fare, overnight accommodations, meals, ground transportation, and tickets to the entertainment event (e.g. , the Super Bowl or a World 113 Appendix D (cont'd) Series game). The only restrictions placed on the Offer are (1) either both customer representatives be employed by the customer in a "decision-making" capacity, or the individual who is not so employed be the spouse Of the attending representative, and (2) the representative be willing to attend both seminars and consider the possibility of future purchases from Panel World. During the seminars customer representatives were shown new products and techniques employed by Panel World in the manufacturing Of veneered wood products, and introduced to alternative applications for Panel World's products. At the close Of the Saturday seminar an informal "refreshment hour" was held where sales representatives and upper management of Panel World individually approached potential customers in the effort to obtain additional sales and learn Of specific customer needs. Arrangements were made with the host facility to provide suitable space for all functions. Thirty firms sent representatives to Panel World's first weekend sales seminar, which was held in conjunction with the 1989 Super Bowl. Twenty-two made purchases either during or subsequent to the weekend. Of the attending firms only fourteen sent two customer representatives. Fourteen of the remaining representatives were accompanied by their spouse; two representatives were accompanied by children. Representatives arrived Friday evening and were greeted by employees Of Panel World. Saturday's seminar began at 9:00 a.m. and ended at 5:00 p.m., with a two hour break allowed for lunch. The refreshment hour commenced at 6:00 p.m. and spouses were actively encouraged tO attend. During formal seminars spouses were Offered the Option to participate in a sight-seeing tour Of the host (in this case, New Orleans) city. Sunday's seminar began at 9:30 a.m. and ended at 12:30 p.m.. Transportation was provided at 3:00 p.m. to the Super Bowl. NO business was discussed either at or after the game. Return flights for customers.to their home city were scheduled to depart Monday morning. As the company controller, Thomas has taken pains to scrupulously document each activity engaged in, and dollar amount incurred, during the weekend. Twenty representatives of Panel World attended the seminars, including Thomas Buchanen and nineteen salespersons. TO staff a hospitality desk, pass out name tags and agendas, accompany non- participating attendees, and perform other tasks necessary to free Panel World's employees, all twenty Of Panel World's employees were accompanied by their spouse and ten employees brought a total Of twenty children (ages 14 through 19). The 114 Appendix D (cont’d) total cost for the weekend was $204,000 and was incurred as follows: Customer Spouses Children EEEEQ. 89959 Q£_B§B§1. Q£_BQRSI Tickets' $ 3,000 $ 2,200 $ 700 $ 100 Airfare 45,000 33,000 10,500 1,500 Accommodationsb 55,999 99,699 i2,690 1,899 Total 9199.999 9M 0 929.992 59.499 Employee Employee T9931 299192995. 5999995 thldren Tickets' 5 3,000 $ 1,000 $ 1,000 $ 1,000 Airfare 45,000 15,000 15,000 15,000 Accommodationsb 95,990 18,009 19,909 19,999 Total §l0§,000 3 00 3 00 §39,990 {Amounts stated at 80% Of the actual expense incurred. bAmounts include 80% of the actual expenses for food, beverages, and entertainment, and souvenirs not exceeding $25 per person. However, despite the extensive marketing efforts, the year has not been a good one for Panel World. A general decline in sales has reduced gross income to $10,000,000. The revised estimate Of taxable income, not including any deductions for the sales seminar, is $900,000. Facing a temporary, but significant, cash flow problem, Thomas has indicated to you a need to take eve e uc ' w ' so e su ort , including those that. may be challenged by the IRS (if detected). In addition, he does not want any additional disclosures (or "red flags" as he terms them) calling attention to Panel World's tax return. Thomas, a CPA, realizes that this could result in penalties assessed against Panel World and, as Panel World's preparer, you. However, he is quite adamant about taking these deductions and, you believe, will compensate you for any penalties incurred. Similarly, you also believe that if you do not assume an aggressive stance on Panel World's return, Thomas will Obtain a new preparer. 115 Appendix D (cont'd) A.review'of the.client's.history’with.your firm indicates that in prior years Panel World’s returns have proven uncomplicated. FEES FROM COMPLETING EARLIER RETURNS WERE A HIGHLY SIGNIFICANT PERCENTAGE OF YOUR OFFICE GROSS REVENUES, with time spent by Office personnel commensurate with the fee received. Upon reviewing the relevant tax authorities you have determined that consenting to the client's wishes raises the possibility Of a preparer Section 6701 penalty relating to the aiding and abetting of an understatement of tax liability, and possible referral to the IRS Director Of Practice for disciplinary proceedings. W113 IRC section 162 provides the initial test of deductibility for these expenditures. Under this section entertainment, meal, and travel expenditures are deductible if they are ordinary and necessary expenses incurred.in the Operation.of a trade or business. Regulation section 1.162-2(a) further specifies that traveling expenses must be "reasonable and necessary in the conduct Of the taxpayer's business and directly attributable to it." If the trip includes both business and personal activities, the travel expenses will only be deductible if the primary purpose Of the trip is business; a facts and circumstances test (Reg. Sec. 1.162-2(b)(1)). One fact that must be considered is the amount of time devoted to each activity (Reg. Sec. 1.162-2(b)(2)). IRC section 162(a)(2) and Regulation Sec. 1.274-1 require the expended amounts for meals, lodging, and entertainment be neither "lavish [n]or extravagant under the circumstances." Upon satisfaction Of IRC section 162, section 274 further specifies that meal and entertainment expenses be either "directly related to" or "associated with" the active conduct Of business. The "associated with" test requires a substantial and bona fide business discussion, with a clear business purpose, directly following or preceding the entertainment (Reg. Sec. 1.274-2(d)). "Substantial and bona fide" requires that the taxpayer's purpose be to Obtain income or other specific business benefit, but.thisIdoes not.preclude goodwill expenditures. The meeting must also be substantial in relation to the entertainment. However, this will be satisfied if the principal character Of the combined business and entertainment activity was the active conduct Of business (Reg. Sec. 1.274-2(d)(3)(i)(a). Regulation Sec. 1.274- 2 (d) (3) (ii) also specifies that entertainment occurring on the same day as the business discussion will be considered to directly proceed or follow the discussion. 116 Appendix D (cont'd) In order for the expense to be considered "directly related": (1) the taxpayer must have more than a general expectation Of deriving income or benefit, (2) during the period of entertainment the taxpayer must actively engage in business activity, (3) the principal character of the combined business and entertainment activity must be the active conduct of the taxpayer’s business, and (4) the expenditure must be allocable to the taxpayer and person(s) engaged in the active conduct of business (Reg. Sec. 1.274-2(c)(3)). It is not necessary that more time be devoted to business than entertainment. In addition, the regulations clearly specify that, absent clear proof, expenses incurred with regard to sporting events will generally not be considered directly related. With regard to family members Of Panel World's employees, Regulation Sec. 1.162-2(c) allows a deduction for travel expenditures only if a bona fide business purpose existed for their presence. In Weatherford (418 F.2d at 879), this required that the member provide "substantial services directly and primarily related" to the business function of the trip. In Danville Plywood (90-1 USTC 50,161), this required that their primary function be more than "socially gracious." In Warwick (236 F.Supp. 761) travel deductions were allowed for a spouse who extensively socialized with customers thereby directly contributing to sales. For family members Of both Panel World's employees and customers, Reg. Sec. 1.274-2(d) allows the treatment of entertainment expenditures as "associated" entertainment if the cost Of entertaining the customer is deductible as either "associated" or "directly related" entertainment and the recipient is closely connected with a person engaged in a substantial and bonafide business discussion. The regulation clearly states that spouses are "closely connected." For all attendees, the amount Of deduction allowed for meals and entertainment expenses meeting either Of the above tests is limited to 80% Of the expense incurred (IRC Sec. 274(n)). In addition, IRC section 274(b)(1) limits the annual total of business gifts to $25jper person and IRC section 274(1) limits the deductible amount for tickets to their face value. 117 Appendix D (cont'd) Mark your response to the following questions based on the client information above. .Assume you are currently preparing Panel World's tax return. 1. What do you believe is the probability that the IRS will allow the entire amount of the expense on audit (assuming the relevant facts are discovered during the audit)? (marked response can be at nny point on the scale) [nil l. l l l l l l l l l J l l l l l l l J 0% 25% 50% 75% 100% What do you believe is the probability that the IRS will discover these facts on audit? L l l J. L l l 1,41 l 11 l l l l l l l l l l 0% 25% 50% 75% 100% Prior to filing the return, would you advise disclosure if the client did not impose any pre-conditions? (CIRCLE ONE) Yes O O O O O O O O O O O O O O O O O O O O O 1 No O O O O O O O O O O O O O O O O O O O O O 2 If you would not advise disclosure, why not? (CIRCLE the ONE primary reason only) The law is clear; amount is definitely deductible O O O O O O O O O O O O O O O O O 1 Substantial authority exists for the deduct ion O O O O O O O O O O O O O O O O O 2 A realistic possibility of success exists . . 3 The law is unclear but, I will favor the client . . . . . . . . . . . . . . . . . . . 4 118 Appendix D (cont'd) Using the following scale as a guide, circle the extent of your agreement or disagreement to each of statements 5 through 8: Strongly Disagree . Somewhat Disagree . Neutral . . . . . . Somewhat Agree . Strongly Agree . . .. . .. .. . .. .. . .. .. . .. . .. .. . .. .. . .. .. . .. .. . .. cubeiwia (CIRCLE ONE FOR EACH) Strongly Strongly Disagree Neutral Agree 5. The strength Of authority for the entire non- disclosed deduction (including expenses for spouses and children) is sufficient to avoid a taxpayer penalty . . . . . . 1 2 3 4 5 6. I feel comfortable with not disclosing additional information on the return . . 1 2 3 4 5 7. Qigcontinuing the engagement would not violate my ethical standards . . . . . . . . . . 1 2 3 4 5 8. Continuing the engagement would not violate my ethical standards . . . . . . . . . . 1 2 3 4 5 119 Appendix D (cont'd) Debriefing Questions 1. Was sufficient information provided to respond to the questions asked? (CIRCLE ONE) Yes O O O O O O O O O O O O O O O O O O O O O 1 No O O O O O O O O O O O O O O O O O O O O O 2 2. If not, what was missing? 3. In your opinion, was the case realistic? (CIRCLE ONE) Yes O O O O O O O O O O O O O O O O O O O O O 1 No O O O O O O O O O O O O O O O O O O O O O 2 4. If not, what specifically was not realistic? 5. Have you been involved in a actual tax situation similar to the one described in the case? (CIRCLE ONE) Yes . . . . . . . . . . . . . . . . . . . . . 1 No O O O O O O O O O O O O O O O O O O O O O 2 120 Appendix D (cont'd) 6. Assuming the case was real, would Panel World be an important client to your firm? (CIRCLE ONE) Yes O O O O O O O O O O O O O O O O O O O O O 1 No O O O O O O O O O O O O O O O O O O O O O 2 7. Did you consider the potential Internal Revenue Code penalty severe or mild? (CIRCLE ONE) severe O O O O O O O O O O O O O O O O O O O 1 Mi 1d O O O O O O O O O O O O O O O O O O O O 2 8. Any other comments? _ BIBLIOGRAPHY 121 BIBLIOGRAPHY American Bar Association, "Taleetu n Advice; Reconsideration of Formal Opinion 314," ABA Formal Opinion 85-352, July, 1985. American Institute of Certified Public Accountants, "Statements on Responsibilities in Tax Practice, Interpretation No. 1-1,” AICPA, 1990. American Institute of Certified Public Accountants, "Statements on Responsibilities in Tax Practice,” AICPA, 1988 (SRTP [1988 Rev.]). Ayres, F. L., B. R. Jackson, and P. 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