Taxes can be very complicated, and many people rely on accountants or other professionals to help them prepare and submit their tax returns and other required forms and documents. Unfortunately, taxpayers may encounter situations where they find that tax returns submitted to the IRS or the California Franchise Tax Board (FTB) contained incorrect information due to errors made by a tax return preparer. When a taxpayer faces a tax audit or tax penalties based on tax returns prepared by someone else, they will need to understand how to address these issues.

Liability for Tax Return Errors

When a taxpayer signs and submits a tax return, they are legally responsible for addressing issues related to the information they submitted. This is true regardless of whether the tax return was prepared by another person. This means that if the information provided on a tax return was incorrect, the taxpayer will usually be responsible for paying any taxes that are owed, as well as any penalties that may apply.

If there are issues related to a tax return, a taxpayer can review the contract they signed with the tax return preparer to determine their options. A contract may specify the obligations that apply to the preparer and detail the procedures that will be followed in these situations. If the preparer agrees that they made errors when preparing the tax return, they may be required to submit any required corrections to the tax return in question, and they may be obligated to cover penalties or interest related to their errors. However, the taxpayer will be required to pay any taxes that are owed.

The U.S. tax system is complex, and there are a variety of issues that could trigger tax audits by the IRS, potentially leading to penalties. Audits can be a significant area of concern for people who are self-employed or who own small businesses. In these situations, it is important to understand the information that a taxpayer will need to provide to the IRS and the issues that may be raised during an audit.

Audit Information Related to Profits, Losses, Deductions, and Expenses

During an audit, the IRS may request a variety of records or other information that supports the information reported on a tax return. These records may be related to:

• Income - All forms of income that a person earns must be reported to the IRS. It is important for self-employed taxpayers to maintain accurate records of all sources of income. This can sometimes be difficult for those who regularly conduct cash transactions. Large deposits into a bank account or major purchases made using cash may be reviewed by the IRS, and a taxpayer will usually need to provide documentation showing how these amounts were earned.

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U.S. taxpayers are generally required to file annual tax returns, and if the proper forms are not filed by the applicable deadlines, a person may face a failure-to-file penalty. Failure-to-pay penalties may apply if a person does not pay any amounts owed at the time they file a tax return. These penalties may cause significant financial difficulties. Fortunately, taxpayers have options for penalty abatement. One option available in certain situations is a first time abatement (FTA) waiver.

Eligibility Requirements for First Time Abatement

First time abatement is a one-time option that may allow a taxpayer to receive relief from failure-to-file or failure-to-pay penalties. Employers who have been assessed failure-to-deposit penalties may also qualify for FTA waivers. If a request for penalty abatement is granted, the taxpayer will not be required to pay the penalty.

To qualify for an FTA waiver, a person will need to meet the following requirements:

Employers in California need to address a number of tax-related issues, and one area that has caused confusion in recent years involves worker classification. Whether workers may be treated as employees or independent contractors is a significant question that has been raised due to the passage of AB 5 in 2019. This law limited the situations where workers may be classified as independent contractors. 

Because the trucking industry has been affected by this law, the California Trucking Association (CTA) filed a lawsuit against the state of California seeking to block this law. This lawsuit claimed that federal regulations under the Federal Aviation Administration Authorization Act (FAAAA) prohibited the state from putting these types of tax laws in place. The 9th U.S. Circuit Court of Appeals had ruled that AB 5 is a general labor law that is not affected by the FAAAA. The CTA appealed to the U.S. Supreme Court, but the Supreme Court decided in June 2022 not to hear the case. This decision maintains AB 5 in place for the trucking industry.

How Does AB 5 Affect the Trucking Industry?

Under AB 5, a process known as the “ABC test” is used to determine whether workers should be considered employees or independent contractors. This three-pronged test states that a worker can only be classified as an independent contractor if all of the following requirements are met:

There are a variety of situations where U.S. taxpayers may face penalties related to foreign assets. Some taxpayers are required to report these accounts to the IRS by filing a Foreign Bank and Financial Account Report (FBAR). Failure to file these reports when required or failure to include accurate information when filing can result in significant penalties. However, there has been some confusion about what constitutes a violation and what penalties may apply. The U.S. Supreme Court will be addressing this issue in an upcoming case.

Penalties for Non-Willful FBAR Violations

Different courts have addressed FBAR violations in different ways, and this has resulted in different penalties being applied depending on where a case was heard. The confusion involving FBAR penalties is related to non-willful violations, or situations where a person did not properly report foreign accounts because they were unaware of how the tax laws applied to them or did not know about their reporting requirements. Courts have differed on whether penalties should apply based on a report that was incorrect or based on each individual account that was not reported correctly.

Depending on how FBAR violations are handled, the penalties that taxpayers could face may be much higher if their cases are handled in certain courts. The Court of Appeals for the Ninth Circuit has ruled that FBAR penalties apply on a “per form, per year” basis. This means that no matter how many accounts are included on a form, a single penalty will apply for each year in which a form was not correctly prepared and filed. However, the Court of Appeals for the Fifth Circuit has ruled that penalties apply on a “per account, per year” basis, and a taxpayer may be required to pay a penalty for each account that was misreported even if on a single form.