Conflicts of interest: Protecting your clients and your practice

Technical expertise is essential to a successful tax practice, but professional judgment is equally important. One area where judgment can be tested is conflict of interest. While many practitioners associate conflicts with attorneys or corporate executives, tax professionals regularly encounter situations in which competing interests can affect, or appear to affect, their ability to represent a client objectively.

Conflicts of interest are more than an ethical concern. They can undermine client trust, complicate IRS representations and expose practitioners to Circular 230 compliance issues. The IRS Office of Professional Responsibility (OPR) recently reminded practitioners of the conflict-of-interest rules contained in Circular 230, emphasizing the importance of identifying and addressing conflicts before they become problems.

Understanding conflicts under Circular 230

Circular 230 defines a conflict of interest in two primary ways. First, a conflict exists when a practitioner's representation of one client is directly averse to that of another client. Second, a conflict exists when there is a significant risk that representation of a client will be materially limited by responsibilities to another client, a former client, a third party or the practitioner's own interests.

Although these definitions may seem straightforward, applying them in practice is not always easy. Conflicts are not limited to situations where clients are openly disputing with one another. In many cases, a conflict develops gradually as circumstances change, making continuous monitoring an important part of client representation.

When routine engagements become complicated

Many conflicts arise from engagements that initially appear routine.

Consider a married couple whose joint return is selected for IRS examination. During the examination, one spouse decides to pursue innocent spouse relief. The practitioner who has been representing both spouses may suddenly find that the interests of one client are directly averse to those of the other. What began as a straightforward examination now requires a careful evaluation of whether continued representation is appropriate.

Similar concerns can arise when representing partnerships and partners, corporations and shareholders, or estates and beneficiaries. In each case, parties may share common objectives at the start of an engagement but develop competing interests as tax issues unfold.

Personal interests can create conflicts

Not all conflicts involve multiple clients. Sometimes the practitioner's own interests are the source of the problem.

For example, a practitioner may recommend a tax position and prepare a return reflecting that advice. If the IRS later examines the return, disallows the position and proposes penalties, the practitioner could face scrutiny as the return preparer. The practitioner's interest in avoiding penalties, preparer sanctions or reputational harm may interfere with the ability to provide objective advice regarding the client's options.

Financial interests outside the practice can also create concerns. A practitioner who has a business relationship, outside employment or family financial interest connected to a client's tax matter may experience divided loyalties. Even when no actual bias exists, the appearance of a conflict can damage confidence in the representation.

The importance of early conflict screening

The most effective conflict-management strategy is prevention.

Before accepting a new engagement, practitioners should gather sufficient information to identify potential conflicts involving current clients, former clients and third parties. Client intake procedures should include questions that help uncover overlapping interests, prior representations and relationships that could affect professional judgment.

Conflict reviews should not end once an engagement letter is signed. Tax matters often evolve over months or years. New facts, business transactions and IRS actions can create conflicts that did not exist when representation began. Periodic reviews help practitioners identify emerging issues before they jeopardize the engagement.

Use engagement letters strategically

A well-drafted engagement letter can be one of the most effective tools for managing conflicts.

Clearly defining the scope of representation helps establish expectations and may reduce the likelihood of misunderstandings. Engagement letters can also describe how foreseeable conflicts will be addressed if they arise during the engagement. Limiting representation to specific matters may allow a practitioner to avoid conflicts that would otherwise develop through broader involvement.

When a conflict cannot be adequately managed, declining a new engagement or withdrawing from an existing representation may be necessary. Practitioners should ensure that any withdrawal is timely and does not adversely affect the client's interests.

When informed consent may allow continued representation

Not every conflict requires ending a client relationship. Circular 230 permits continued representation in certain circumstances.

To proceed, the practitioner must reasonably believe competent and diligent representation can be provided to each affected client. The representation cannot be prohibited by law, and each affected client must provide informed written consent after the conflict has been fully disclosed.

The written consent generally must be obtained within 30 days after the conflict becomes known and retained for 36 months after the representation ends. Maintaining thorough documentation is essential if questions arise later regarding compliance.

Review your intake practices

Conflicts of interest are not limited to large firms or high-profile cases. They can emerge in everyday tax practice, often when circumstances change unexpectedly. Establishing strong intake procedures, conducting periodic conflict reviews and maintaining thorough documentation can help practitioners identify and address conflicts before they become compliance concerns. By remaining vigilant, tax professionals can protect their clients and uphold the professional standards expected under Circular 230.