WISE-HOLLAND CORPORATION

On June 15, 2017, Marianne Wise and Dory Holland came to your office for an initial

meeting. The primary purpose of the meeting was to discuss Wise-Holland Corporation's

tax situation. Marianne Wise and Dory Holland each own 50% of Wise-Holland

Corporation, an S corporation. Dory and her husband will continue to use another tax

accountant for their on-going work, but Marianne wants to engage your services for her

personal tax return. Marianne is not married.

Wise-Holland is a calendar year corporation established in Naples, Florida on January 1,

2001. The corporation's principal business is locating and selling unique interior design

items. Marianne and Dory have been friends since college where they were both art

majors. After graduation, they each held various positions where they gained experience in

interior design before joining together to start this business. They are pleased but stunned

by the financial success of their business, because the initial business plan was simply to

focus on what they liked to do and have more flexible schedules than they had as

employees of others. They feel very dependent on their accountants and other financial

advisers because they have no experience or training in financial matters.

Marianne is unhappy with her tax accountant (Amanda Klinger) who prepared her individual

tax return and advised her on tax issues for the past ten years. Specifically, she is

dissatisfied because she had received a notice of deficiency from the IRS disallowing

deductions on her 2011 tax return from a partnership investment she made in that year.

The partnership was small partnership and not subject to the unified audit and litigation

procedures. Because the partnership was under audit, Marianne signed a waiver

extending the statute of limitations for her 2001 individual return for three years. In addition,

she and Dory just received an audit notice for Wise-Holland's 2013 S corporation tax return.

You have never prepared or reviewed Marianne's individual return or Wise-Holland's

corporate return. In your initial meeting with Marianne and Dory, you gathered all essential

information to begin your engagement. You have obtained the following documents.

Marianne's individual tax returns for tax years 2010 through 2015. These returns

have been timely extended and filed on August 15 of the appropriate year.

Marianne's filing status was "single" for all of these returns. Her annual taxable

income during these years was approximately $150,000-$200,000.

S corporation tax returns for tax years 2010 through 2015. These returns were

timely filed on March 15 of the appropriate year.

An installment note for the sale of land, building, and equipment by Marianne in

2014.

The notice of tax deficiency from the IRS for Marianne's 2011 tax return.

The audit notice dated June 1, 2017, for Wise-Holland's 2013 tax return.

Various information and financial records necessary to compute 2017 taxable

income for Wise-Holland and Marianne Wise.

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A review of these documents and discussions with Marianne and Dory provided the

following additional information. None of the taxpayers has engaged in a tax shelter

transaction.

Notice of Deficiency Mariannes 2011 tax return

The notice shows a tax deficiency of $50,000 resulting from the disallowance of deductions

from the partnership. The stated reason for the disallowance was that the partnership did

not have a profit motive. In addition to the tax deficiency, the notice reflects interest and a

20 percent penalty for substantial understatement of tax liability.

Marianne relied on a qualified advisor to make a good faith effort to evaluate the legitimacy

of the partnership; she was not negligent in claiming the deductions from the partnership on

her individual return. Marianne is perturbed because Amanda assured her that the tax

return positions were reasonable and there was little risk the IRS would disallow the

deductions. Marianne is also perturbed about the penalty because she did not intentionally

understate her tax liability. When she discussed the penalty with Amanda, Amanda told

her there was no recourse; she would just have to pay the tax deficiency, including the

interest and penalties. The IRS' disallowance only affects the 2011 tax year.

Installment Sale

In 2014 Marianne sold land, building, and equipment for $300,000. She received an

installment note payable at the rate of $60,000 per year for five years. The installment sale

was reported in Marianne's 2014 tax return. The basis of the property was $150,000. The

total gain and character of the gain is as follows.

Selling Price $300,000

Basis 150,000

Total Gain Realized $150,000

Section 1245 $100,000

Section 1231 50,000

Total Gain Recognized $ 50,000

Marianne had a $75,000 capital loss carryover to 2014. Therefore, Amanda decided to

prepare Marianne's returns reporting $30,000 of 1231 gain in 2014 and $20,000 in 2015

to utilize the capital loss carryover as quickly as possible. The table below reflects the way

Amanda reported the transaction.

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RETURNS AS FILED--EFFECT ON GROSS INCOME

2014 2015 2016

Section 1245 $0 +$10,000 +$30,000

Section 1231 +$30,000 +$20,000 $0

Loss C/O Offset -$30,000 -$20,000 $0

Net Effect on Gross

Income $0 +$10,000 +$30,000

Audit Notice Wise Hollands 2013 tax return

The audit notice for Wise-Holland questions certain deductions claimed on the return on the

basis that they are nondeductible personal items. Based on your review of the detail and

discussions with Marianne and Dory, you conclude that certain deductions should have

been characterized as personal expenditures and are not deductible by the S corporation.

When Wise-Holland's return was originally prepared, Marianne and Dory believed these

deductions were valid business expenditures and made a good-faith effort to segregate

their personal expenditures from their business expenditures. You do not believe the IRS

can make any adjustment, because it has been three years since Wise-Holland filed its tax

return.

Ambiguous Tax Issue

In your review, you identified an expense in the financial statement that presents an

ambiguous tax issue for the S corporation's 2016 tax return. The amount of tax relating to

this issue is approximately $10,000 and you estimate that it will exceed 10% of the total tax

liabilities for Marianne and Dory for 2017. After reviewing the relevant facts and law, you

found six trial court cases that support the IRS position. One old federal District Court

decision in Florida supports the taxpayer's position. The only appellate court decision (10th

Circuit) supports the IRS position (reversing a Tax Court decision). The Wise-Holland

expenditure is quite similar to those discussed in the court cases, although some minor

distinctions exist. In your view, there is a meaningful distinction between the Wise-Holland

expenditure and that presented in the 10th Circuit case. You have assessed Wise-Holland's

chances of prevailing on the issue to be very small if litigated. After you explained your

preliminary evaluation of the weakness of their position, Marianne and Dory stated that they

want you to prepare the return taking the favorable position, which will require disclosing

the position on the return.

Other

You have done some research that indicates that in certain circumstances, the preparer of

apassthrough entity's tax return and K-1s can be deemed to be the preparer of an

individual's Form 1040 on which the data from the passthrough entity's return was entered.

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Section 7701(a)(36) defines the term "income tax return preparer" to include any person

who prepares returns a substantial portion of a return for compensation. Reg. 301.7701-

15(b) provides that the determination of whether a schedule, entry, or other portion of a

return is a substantial portion is determined by the length, complexity, and tax liability of the

return. The question then is whether the K-1 numbers constitute a "substantial portion" of

the return.

Required

1. Determine your general responsibilities as a CPA under the AICPA's Statements on

Standards for Tax Services (SSTSs) and Treasury Department Circular 230 (Circ. 230).

Prepare a chart summarizing taxpayer and tax practitioner reporting standards. Also

evaluate the potential penalties applicable to practitioners and taxpayers under the

Internal Revenue Code.

2. Identify all procedural and reporting issues that exist in the Wise-Holland facts. In

particular, you should address the following issues.

Relevant statutes of limitations

Applicable interest provisions

3. Evaluate the first three issues (Notice of Deficiency, Installment Sale, and Audit Notice)

from the perspective of the taxpayer, taking into account the pertinent tax practitioner

responsibilities and penalties.

4. For the ambiguous tax issue, analyze the conclusions a CPA must draw in deciding

how to advise a client regarding an ambiguous tax position and in determining whether

he or she can sign a tax return and comply with statutory standards, the SSTSs, and

Circ. 230. Analyze all possible results, from a conclusion that a position has substantial

authority to a conclusion that a position is frivolous.