You are currently a Senior Manager at a small CPA firm (the firm). You have been a senior manager for a while and have started building your book of business in order to make partner.

You were approached by Draco Malfoy, the owner of Dracos Scrap Metal, Inc. (the Company), about doing that companys federal and state income tax return preparation work. Draco was referred to you by a current tax client.

During your first meeting, Draco tells you that he grew up in the scrap metal business and worked at his fathers business, Luciuss Scrap Metals. He then decided to start his own scrap metal business. He started with collecting metal scrap from building construction and renovation sites and then was able to add on scrap aluminum and beverage can recycling as well as collection and reconditioning of auto parts. The Company now has 15 employees, and the business was earning $4 million a year in gross revenues and now one of the largest scrap metal dealers in town.

Draco is an engaging character who is instantly likable and a great bargainer. He spends the first part of your meeting relaying funny stories of how he got bamboozled in his early days by peddlers who sold him chrome-covered iron and claimed it was stainless steel, and who would have removed mill markings on aluminum to upgrade the metal to the next best price point. Draco seems wise beyond his years, and you quickly conclude that he is knowledgeable of his business and the industry.

When the subject of your services comes up, Draco explains that his current CPA is a sole practitioner who is trying to wind down his practice, so Draco is now looking for a firm with a strong tax and planning background.

You have heard of Dracos current CPA, a practitioner named Barty Crouch, Jr., who was actively involved in structuring a few tax shelters that caught the Internal Revenue Services attention over the years but who managed to avoid any serious repercussions. When you ask Draco if he happened to be an investor in any of these, he tells you that Barty set up the shelters with a lawyer from New York and convinced Draco that it was a good investment. However, Barty realized that he was hoodwinked by the lawyers, and eventually helped Draco defend the shelter in an IRS proceeding. Draco ended up having to pay more taxes, interest, and penalties, but thinks that thats what it costs for making money. You wonder if Barty was as innocent as Draco seems to believe.

You move on to talk to Draco about how you can help him in his estate, financial, and business succession planning. Draco was impressed and mentions that your current clients speak highly of you and your reputation. You continue to discuss with Draco about the business matters like recordkeeping, inventory valuation, cost allocations, and Draco appears really knowledgeable in these areas. He then writes a check of $20,000 to your firm to get the ball rolling and tells you to bill him whatever your rate is as you perform the services.

You thank him and walk him to the parking lot and then wave goodbye as he drives away in his beat-up old pickup. You go back in the office and report this new client to the partners, who are happy to pick up another good client with plenty of prospects for present and future work. You are excited to bring the business as it gets you closer to your partner promotion.

Present Time

It is now October and you have just completed filing Dracos tax returns (note: extension to file a tax return is 10/15). You have also completed a compilation for Draco as the Company has a revolver of the local bank. You have also worked with Draco on getting some estate planning done and have helped the Company transition into a new state of the art software system for accounting and inventory tracking. Throughout this time, you have found yourself liking Draco even more he is down to earth, savvy businessman, great storyteller and a real jokester. With the work that you have earned from the Company along with other clients you brought in, the partners of the firm have told you that effective January 1^st of next year, you will be officially promoted to Partner.

As the year-end approaches, you contact Draco to meet with him for yearend tax planning. When he arrives, his beat-up pickup is nowhere to be seen, and Draco now drives a brand-new Mercedes Benz. You are familiar with the model and know that the price tag is $175,000.

You: You must have sold one heck of a lot of metal to afford something like this!

Draco: Hey, this is the reward for all those late nights and long stretches with no vacations

You: I guess its a good thing you and I were getting together to do some tax planning, because it sure looks like youre going to need it!

Draco: Hey, listen, most of this came from the rainy, so we wont have to worry about that when it comes to taxes.

You pause, unsure where to go with this, but decide to tread lightly: Draco, what do you mean, the rainy?

Draco laughs aloud, sounding amazed. Hadnt I mentioned the rainy before? The rainy, or short for the rainy-day fund, was just my way of putting aside some cash from the scrap that we "couldnt sell no place else". I found a buyer whod take the odds and ends that wed usually throw away, and they always paid in cash. Ive been saving in the rainy for about four years now, I figured it was about time to enjoy some of the harvest from all this hard work!

You frown, knowing that the sale of scrap is considered taxable income: Draco, you never told me about this.

Draco sees the frown on your face. Now, come on, youre not angry about the rainy, are you? Everybody does it in our business, and I kind of thought it was OK because our old accountant Barty knew about it and he said it was all right.

Prompt: Use the EDM model to determine what you should do about the situation. Make sure to apply applicable professional rules and codes.