Reporting misconduct can bring surprises for tax pros

When reporting someone else’s misconduct, most tax preparers believe they’re doing the right thing. The surprise is that the “right” move can still create an ethics problem if you share the wrong information with the wrong person.

Confidentiality rules are often stricter than people realize. Even when you are confident that something unethical happened, you may not be allowed to disclose client information to address it. You can take action, but you cannot always report it the way you might expect.

Quick takeaways for tax pros

• Your first duty is often to advise the taxpayer of the issue and its consequences, not report it to the IRS.
• Circular 230 generally points you toward informing the taxpayer and recommending corrective action. 
  • It does not create a general duty to report the client to the IRS.
• If the client refuses to allow disclosure during an audit or appeal, consider withdrawing.
• Confidentiality rules can block well-intended reporting, even if you withdraw from the engagement.
• State board rules and industry standards may overlap, but they do not always give you a clear path for disclosing client information, even when you are trying to do the right thing.

Reporting nuances that surprise people

There is a difference between addressing unethical conduct and disclosing confidential client information.

Most standards allow, and sometimes require, you to:

• Tell the client what you found
• Explain the consequences
• Recommend corrective action
• Refuse to sign or support a position you cannot defend
• Withdraw from the engagement or representation when appropriate

Those same standards may restrict you from:

• Notifying the IRS about a client issue without permission
• Contacting a regulator and sharing client details to set things right
• Using information from one client’s file to explain another client’s problem
• Disclosing client tax return information to a third party without written consent
• Sharing details that identify a client, even if you do not include the return itself

You can often ask a client for missing or corrected documentation, but you still have to be careful about what you disclose. Disclosing return information without a permitted exception, such as client consent or a legal requirement, is not just an ethics misstep. It can trigger civil penalties under §6713 and even criminal exposure under §7216.

Scenario 1: You find a client error or questionable position

A new client brings you prior-year workpapers, and you notice a large “consulting” expense that looks like personal spending, meals, retail charges and cash app transfers, all coded as business deductions. That is a red flag, even if the client insists, “My last preparer said it was fine.”

You can advise the client and recommend corrective steps, or potentially withdraw. But you generally cannot disclose the client’s tax return information to the IRS on your own, even if you think the client did something wrong.

Scenario 2: You spot misconduct by another preparer

You review a client’s prior-year return and see a Schedule C with large deductions that do not match the client’s business, like a mileage deduction that implies 40,000 business miles for someone in a mostly remote position. The client says, “My old preparer told me everyone does it.”

Start by separating the two questions:

• What is your obligation to your client right now?
• Can you report the other preparer without disclosing confidential client information?

Your first move is to protect the client and your practice by focusing on compliance. Ask targeted questions and request documentation. Make it clear which items cannot be supported based on the evidence you have been given. If the facts do not support the prior-year positions, recommend the cleanest corrective path and document your advice.

If the client wants to file a complaint against the preparer with a state board, you can support the process. But remember, federal confidentiality rules under §7216 generally prevent you from disclosing the client’s return information to a regulator without the client’s written consent. In many cases, the cleanest path is a client-driven complaint using the client’s own documentation, with your role limited to what the rules allow.

The fact that the concern involves another preparer does not remove the confidentiality issue. If the facts came from your client’s file, they may still be protected return information.

A quick guardrail

• Am I disclosing anything that identifies a client or reveals return information?
• Do I have written permission, or a clear exception that allows disclosure?
• Can I act without disclosure, by withdrawing, refusing to sign, limiting scope or advising the client on options?

Do not confuse confidentiality with privilege. The §7525 privilege is limited and generally does not protect communications made for the preparation of returns.

Final misconduct-reporting takeaway

When misconduct surfaces, your obligation is usually to inform the client, explain corrective action and consequences, and document everything. If the client refuses to move forward appropriately, withdrawal may be necessary. But even then, confidentiality rules still apply. In some cases, the safest path is not to report the client but to keep the client in the driver’s seat while you stay within the disclosure rules.

Discover more about ethics, like Circular 230 and due process: what tax pros should know, at NATP’s Ethics for Tax Professionals hub.