The U.S. Court of Appeals in Chicago recently stuck certified public accountants and others who prepare tax returns with new obligations to determine whether their clients are telling the whole truth. All the court upheld in its Dec. 13 ruling in Brockhouse v. U.S. was a $100 penalty imposed by the Internal Revenue Service, but the decision could well toughen the tone of the relationship between taxpayers and the professionals they hire to fill out their tax forms.
The core of the controversy is a 1976 amendment to the tax code, intended to go after tax preparers who advocate fraudulent approaches in attempts to slice legitimate tax bills. As many read that addition to the law, it authorizes the IRS to fine tax preparers for ignoring IRS rules and regulations.
But the majority on the Chicago court panel interpreted the provision more broadly along the lines of the Treasury Department itself: The amendment can lead to fines in cases where the accountant did not break any specific rule, but simply didn't ask all the questions that a more diligent investigator might have.
That's what happened in Brockhouse. The CPA prepared the tax returns for a physician and for the professional corporation through which he practiced. The doctor had loaned the corporation a major chunk of its start-up money, and received, in the year in question, $15,291 from the corporation as interest on that loan. That payment would have increased the personal tax obligation of the doctor and his wife by $10,538 -- had they reported it. But no mention of the payment ever showed up in the financial data the couple turned over to the accountant.
As the IRS saw it, however, there was enough of a paper trail so that the tax preparer should have asked whether income has been inadvertently omitted. The professional corporation's trial balance sheet showed loans both from the doctor and from a bank, and it also showed expenditures for interest payments, but there was no indication of how the payments were allocated among the outstanding loans. Often the sole owner of a corporation will provide the corporation an interest-free loan. But that possibility didn't let the CPA off the hook; the judges said that by not asking how the interest had been allocated, the CPA was not using the "due diligence" expected of his professional status. It's a good bet that from now on, more accountants will ask that question.
In other cases, courts ruled that:
* A company can lose a federal income tax break if local authorities goof. In general, interest paid on bonds and similar obligations issued by state or municipal authorities is tax-free and need not be included in the income on which federal taxes are computed. A Tennessee firm that sells construction equipment to cities and counties tried to use this exclusion to shelter interest paid by those governments when the equipment was sold on a deferred-payment basis.
But the Internal Revenue Service objected, arguing that the local purchasing agents lacked legal authority to make the time-sale commitments. The IRS won, even though the judges at the U.S. Court of Appeals in Cincinnati agreed that under Tennessee law the sales contracts were valid. Only legally authorized borrowings can give rise to tax-free interest payments, they ruled. (Power Equipment Co. v. US, Nov. 29)
* A corporate officer cannot say "thanks, but no thanks" to an offer to trade immunity from criminal prosecution for testimony in a civil trial. The Iowa Supreme Court told an official of a crayon manufacturer that he had to tell the state attorney general what he knew about allegations of price-fixing in the industry -- even though the testimony might be incriminating -- because the court had guaranteed that nothing the executive said would be used in a criminal case against him.
The obligation to testify exists even though the case is not a criminal prosecution, but a bid by the state to collect money damages from the company, the justices said. And they assured the worried officer that -- even though the Iowa courts only could promise no criminal prosecution in that state -- other states and the U.S. government also would respect the grant of immunity. (Girdler v. Iowa, Nov. 14)
* A ship must be in the water before federal authority admiralty jurisdiction applies. A 1972 law gives harbor workers broad rights to sue when injured by a "vessel," and in November the U.S. Court of Appeals in New Orleans decided that that statute applied to workers injured while on an incomplete ship hull floating in navigable waters. But the judges refused to push the jurisdiction any further. In a ruling 25 days later, they rejected a suit brought by a worker whose injury came aboard a barge under construction, because the boat was not actually in the water, but on a maritime railroad over the water. (Christoff v. Bergeron Industries, Dec. 10
* A corporate officer can become unemployed just like any other worker. The Illinois labor department refused to pay unemployment compensation to a woman laid off by a family-owned business because she continued to serve as an officer of the firm. She had the power to decide if she kept her job or not, the bureaucrats reasoned. But the state supreme court ordered the benefits paid. The court admitted that owners of closely held firms could abuse the system, but ruled that until the legislature tightened the rules, an officer let go from a payroll position has as much claim to compensation payments as anyone else. (Garland v. Dept. of Labor, Dec. 2)