In 2005 KPMG was indicted for promoting abusive tax shelters. The Department of Justice and the Internal Revenue Service on August 29, 2005 reported that:

KPMG LLP (KPMG) has admitted to criminal wrongdoing and agreed to pay $456 million in fines, restitution, and penalties as part of an agreement to defer prosecution of the firm. In addition to the agreement, nine individuals – including six former KPMG partners and the former deputy chairman of the firm – are being criminally prosecuted in relation to the multi‐billion dollar criminal tax fraud conspiracy. As alleged in a series of charging documents unsealed today, the fraud relates to the design, marketing, and implementation of fraudulent tax shelters.¹

After that settlement with KPMG a subsequent indictment was issued against specific individuals and alleged:

… that from 1996 to early 2004 the 19 defendants, KPMG, and others conspired to defraud the IRS by designing, marketing and implementing illegal tax shelters, and focusing on four shelters known as FLIP, OPIS, BLIPS and SOS. It is charged that this illegal course of conduct was approved and perpetrated at the highest levels of KPMG’s tax management and involved numerous KPMG partners and other personnel.

“The development and promotion of abusive tax shelters had a corrupting effect on the legal and accounting professions,” said IRS Commissioner Mark Everson. “Tax professionals should help people pay what they owe – not more, not less.”

According to the charges, the alleged conspirators designed, marketed and implemented the shelters so that wealthy individuals who had large incomes or a large capital gain could eliminate all taxes on that income or gain by simply paying to KPMG all‐in costs and fees of from 5–7% of the income or gain they wished to shelter. The shelters were marketed only to individuals who needed a minimum of $10 million or $20 million in losses, and according to the charges, the defendants and their co‐conspirators filed and caused to be filed false and fraudulent tax returns that incorporated the phony tax losses. In addition, the defendants and their co‐conspirators took specific steps to conceal the very existence of the shelters from the IRS and from IRS scrutiny – by among other things – failing to register the shelters with the IRS as required, and by fraudulently concealing the shelter losses and income on tax returns, according to the indictment.

The indictment also alleges that from 2002–2003, in response to the IRS examination of KPMG for failure to register tax shelters and related matters, certain of the defendants continued the fraud on the IRS by concealing KPMG’s involvement and role in certain shelters; intentionally failing to produce documents that were called for by summonses issued by the IRS; and providing false and evasive testimony to the IRS regarding the nature and scope of KPMG’s involvement with certain shelters. In addition, in connection with the investigation into tax shelters being conducted during the pendency of the IRS examination by a Senate Subcommittee, certain defendants provided false, misleading and incomplete information and testimony at a hearing and a false response regarding documents that were called for in a subpoena issued by the Senate, relating to the personal use of tax shelters by KPMG and certain KPMG partners.

It is hard to imagine anything that can serve to undermine our voluntary system of taxation more than the crimes charged today, where so many professionals banded together with wealthy individuals to perpetrate this massive fraud on the tax system. This was an orchestrated case of deliberate tax evasion, and not legitimate tax planning. Professionals, including lawyers, accountants, bankers, so‐called investment advisors and their firms – as well as taxpayers – should be on notice that the government will pursue even the most complicated tax‐fraud schemes designed to help the wealthy evade paying their fair share.”²

An article in Business Week explains how the BLIPS – “Bond Linked Issue Premium Structures” – which were sold to at least 186 wealthy individuals and generated at least $5 billion in tax losses, worked.

A client would borrow from an offshore bank to buy foreign currency from the same bank. Roughly two months later the client would sell the currency back to the lender, creating what the government contends was a phony tax loss that the client could then deduct from his capital gains and income from other investments.³

The AICPA’s Statements on Standards for Tax Services (SSTS) along with the Treasury Department Circular 230, Internal Revenue Code Section 6694, and the PCAOB Release No. 2008‐003, as well as the various Internal Revenue Code Sections (i.e. 6700, 7408, etc.) dealing with abusive tax shelters, all delineate enforceable standards by which the tax preparer must abide. The Statements on Standards for Tax Services were revised in November 2009, with an effective date of January 1, 2010. The revised SSTS are an attempt to clarify certain inconsistencies or anomalies that were contained in the original SSTS. This chapter will deal with the Statements on Standards for Tax Services (SSTS) in detail. The other standards are mentioned because the tax accountant must be aware and must comply with all standards. Since the published standards are revised and updated on a regular basis, it is the tax accountant’s responsibility to remain current with these standards.

The tax accountant has several responsibilities to the public, through the government. First, the tax accountant has an obligation not to lie or be party to a lie on a tax return. Second, “the signature on a tax return is a declaration under penalties of perjury that to the best of the preparer’s knowledge, the return and accompanying schedules and statements are ‘true, correct, and complete’.”⁴ Consequently, there is a responsibility to both the client and the public to be forthright and not to be complicitous in a client’s attempt to deceive even if that means breaking off a relationship with the client.

Why that’s the case is clearly laid out in the AICPA’s Statement on Standards for Tax Services⁵ No.1, numbers 10 and 11.

1. “Our self‐assessment tax system can only function effectively if taxpayers report their income on a tax return that is true, correct and complete. A tax return is prepared based on a taxpayer’s representation of facts, and the taxpayer has the final responsibility for positions taken on the return”…
2. In addition to a duty to the taxpayer, a member has a duty to the tax system. However it is well‐established that the taxpayer has no obligation to pay more taxes than are legally owed, and a member has a duty to the taxpayer to assist in achieving that result…”

Number 11 clearly spells out the fact that tax accountants have a duty not only to their clients but also to the system. The client’s duty is to pay the taxes they legally owe, no more, no less. The taxpayer has the final responsibility for the representation of the facts and for the positions taken on the return, but the accountant has the responsibility to point out to the client what is legally owed and not owed, and the responsibility not to go along with a client who wants to take advantage of the tax system.

These responsibilities flow from the nature of the tax system. The tax system, which depends on self‐assessment to function effectively, needs everyone to give honest assessments and pay their fair share of taxes.

Some might object that such a position is naïve, since certain taxes are unfair. Didn’t the founding fathers of the United States refuse to pay taxes, which they deemed unfair, because they were taxes established without representation in an undemocratic fashion? One could adopt a position such as that to rationalize cheating the government on taxes. However, in spite of the fact that the founding fathers made such an argument, in a democratic society such a move is filled with peril. Fairness is a notoriously ambiguous concept and in applying it to the evaluation of tax burdens the most prudent course is probably that of adhering to what the society, following its due process of passing determining legislation, decides is fair. The founding fathers of the United States did not rail against taxes, the argument was against taxation without representation. If everyone decided not to pay what is owed there would be chaos in the government. Hence, there should be general agreement to comply with current tax laws, and if one thinks such laws are unfair, to work through the proper procedures to change them.

Not only is working within the system called for, we would claim that the tax accountant should be ruled by the spirit of the law and not just the letter of the law. Still we recognize that this goes against what may be the prevailing business culture to get away with paying as little tax as possible. Consider the following:

In 1993, Goldman Sachs & Co. invented a security that offered Enron Corp. and other companies an irresistible combination.

It was designed in such a way that it could be called debt or equity, as needed. For the tax man, it resembled a loan, so that interest payments could be deducted from taxable income. For shareholders and rating agencies that would look askance at overleveraged companies, it resembled equity.

To top officials at the Clinton Treasury Department, the so‐called Monthly Income Preferred Shares, or MIPS, looked like a charade – a way for companies to mask the size of their debt while cutting their federal tax bill.

Treasury made repeated attempts to curtail their use. In 1994, it scolded Wall Street firms and asked the Securities and Exchange Commission to intervene. The next year, the department sent legislative proposals to Congress aimed at closing loopholes and punishing offenders. In 1998, the Internal Revenue Service tried to disallow Enron’s tax deductions. Each move was beaten back by a coalition of investment banks, law firms and corporate borrowers, all of whom had a financial stake in the double‐edged accounting maneuver.

The MIPS saga shows how moneyed interests, with armies of well‐connected lobbyists and wads of campaign contributions to both parties, defeated the Treasury's efforts to force straightforward corporate accounting. With corporate bookkeeping now under scrutiny, the story of this flexible financial instrument shows how such accounting gimmickry gained acceptance.⁶

We want to argue that such an approach goes against the general tenor of the code of ethics of the accounting practice, and goes against the spirit of the laws that are behind the tax structure of the market economy. The tax laws were developed with certain purposes in mind, certain objectives that were deemed desirable by duly elected officials. Now in any law there are loopholes that can be exploited to take advantage of the loopholes. But applying the Kantian universalizability principle we see that if everyone exploited the loopholes the system would not accomplish what duly elected officials thought we needed to accomplish, and indeed might collapse. It is only because most people abide by the spirit of the law and don’t exploit the loopholes that the laws continue to function. Those who exploit the loopholes are free riders who take advantage of others. That is patently unfair.

Those would seem to be the general ethical considerations that underlie the standards put forward by the Tax Executive Committee of the AICPA in the Statements on Standards for Tax Services. It is interesting to note the opening paragraph of the work: “Standards are the foundation of a profession. The AICPA aids its members in fulfilling their ethical responsibilities by instituting and maintaining standards against which their professional performance can be measured.”⁷ The best indication of the ethical standards that should be met by a tax accountant is found in these standards.

There are seven standards presented in the SSTS. As found in the explanation sections, the following summarize the central themes of each standard:

1. A member should not recommend a tax return position unless it has a realistic possibility of being sustained on its merits.
2. A member should make a reasonable effort to obtain from the taxpayer the information necessary to answer all questions on tax returns.
3. A member may rely on information furnished by the taxpayer or third parties without verification. However a member should not ignore the implications of information furnished and should make reasonable inquiries if the information appears to be incorrect, incomplete or inconsistent either on its face or on the basis of other facts known to a member. Further, a member should refer to the taxpayer’s returns for one or more prior years whenever feasible.
4. Unless prohibited by statute or by rule, a member may use the taxpayer’s estimates in the preparation of a tax return if it is not practical to obtain exact data and the member determines that the estimates are reasonable based on the facts and circumstances known to the member.
5. A member may recommend a tax return position or prepare or sign a return that departs from the treatment of an item as concluded in an administrative proceeding or court decision with respect to a prior return of a taxpayer. However, the member should consider whether the standards in SSTS No. 1 are met.
6. A member should inform the taxpayer promptly upon becoming aware of an error in a previously filed return or upon becoming aware of a taxpayer’s failure to file a required return. A member should recommend corrective measures to be taken.
7. A member should use professional judgment to ensure that tax advice provided to a taxpayer reflects competency and appropriately serves the taxpayer’s needs.⁸

Let’s look at a scenario:

One of your most important clients has strongly suggested that you change the treatment of an item on his income tax return. You believe that the treatment of the item suggested by the client will materially understate the client’s correct tax liability. Further, there is no reasonable basis for the change. You have basically two choices: (1) You could refuse to change the item. (2) You could agree to change the item as suggested by the client. Would you agree to change the item?⁹

According to the standards, it would be unethical to capitulate to the client’s request to materially understate the client’s correct tax liability, since in signing a return you are attesting that the return is true, correct, and complete. To sign it would be to engage in lying and that is a clear cut ethical violation.

But there is an area of tax accounting that is not so clear cut and is problematic. It is the area where there is exploitation of the tax system. Standard one states that: “A tax accountant should not recommend a position that ‘exploits’ the IRS audit selection process.” But what exactly counts as exploiting? What is the ethics of engaging in tax dodge schemes, and are there other areas where the accountant can help the client exploit the tax system and avoid paying his or her fair share of the tax burden?

Consider the following scenarios:

1. You assured your client that a particular expenditure was deductible only to find out later that it was not. However, it is unlikely the item will be detected by the IRS. Do you tell your client about your mistake and change the form, or do you let it stand as it is?
2. You discover that the client’s previous year’s return, which someone else prepared, listed a deduction $3000 in excess of the actual expenditure. The mistake was not intentional and the IRS will probably not detect the error. Should you correct the error, costing your client additional liability? What if you prepared the return the previous year so that the mistake was yours?
3. You are preparing a tax return for a very wealthy client, who can provide you with excellent referrals. You have reason to think the client is presenting information that will reduce his tax liability inappropriately. Should you inquire about the veracity of this information or just prepare the tax form with the information as given?¹⁰
4. The accounting firm you work for sells tax savings strategies to clients, demanding a 30% contingency fee of the tax savings plus out of pocket expenses. The company will defend its ‘strategy’ in an IRS audit, but not in court, and refund a piece of the fee if back taxes come due.¹¹ Is what your company doing acceptable? What obligation do you have?

What do you do in these cases? In making a decision about the appropriateness of these activities, particularly the fourth case, it is important to keep in mind the SSTS statement, “Our self‐assessment tax system can only function effectively if taxpayers report their income on a tax return that is true, correct and complete.” This position is eloquently stated in Justice Burger’s opinion in the landmark Arthur Young case:¹²

Our complex and comprehensive system of federal taxation, relying as it does upon self‐assessment and reporting, demands that all taxpayers be forthright in the disclosure of relevant information to the taxing authorities. Without such disclosure, and the concomitant power of the government to compel disclosure, our national tax burden would not be fairly and equitably distributed.

A system that depends on self‐assessment and reporting puts one in mind of the type of operation which makes golf such an honorable game. The rules of golf exist, and if something happens, for example if a ball moves upon address, it is incumbent on the golfer to penalize herself one stroke. Taxation is similar. It depends largely on self‐assessment and reporting. In that context the fair thing for everyone to do is to police themselves. Our society is based on a large honor system and will work best when most people abide by that honor system. As we noted, those who take advantage of the system are free riders.

There are those who would like to insist that Justice Burger rightly indicates that the success of the scheme rests, not so much on honor as on the concomitant power of the government to compel disclosure. But this does not mean that because the government does not apprehend people it is OK to try to ignore elementary fairness in meeting one’s tax burden. That is why as SSTS No. 1, 7a states, “A tax accountant should not recommend a position that ‘exploits’ the audit selection process of a taxing authority” and SSTS No.1, 7b adds, “or serves as a mere ‘arguing’ position”. Even though some insist that from Justice Burger’s perspective, such schemes as the last may be within the letter of the law, they are certainly not within the spirit of the law, which necessarily requires our national tax burden be fairly and equitably distributed.

What we may have here is a continuum between clearly unethical and illegal practices, practices which may be legal but are unethical, and practices which are ethically acceptable as well as legal.

If one takes the characterization of these moves by accounting firms as “hustling”, “improper” and “schemes” or “abusive”, it is clear that at least from some perspectives the accounting firms are doing something ethically questionable if not downright unethical.

Of course defenders of such practices will argue that these activities are necessary given the competition of the marketplace. Some will argue as did Oliver Wendell Holmes, that we should not pay one iota more than the law allows. Still, every law, being composed by human beings, will probably have a loophole that can be exploited. We would argue that there is something contrary to fairness and the public welfare in attempting to circumvent the obvious purpose of a specific law to give one’s client an edge in getting out of paying one’s fair share of the taxes.

Indeed it can be objected that many taxes are not ethically proper. Nevertheless, many are and their spirit should be met in the interest of fair play. For those that can be shown to be unfair, the answer is not to circumvent the law, but to change it. Taxation, as much as one does not like it, is the human invention that centralizes the sharing of the expense of performing government functions in a fair and equitable manner. To view accounting as a profession best employed in dodging those expenses is a distortion of the role of the accountant.

In 1999 David A. Lifson, former chair of the Tax Executive Committee of the American Institute of Certified Public Accountants (AICPA), made the following statement in testifying to congress.¹³ It indicates the AICPA view of the ethics of tax shelters.

We (the AICPA) strongly oppose the undermining of our tax system by convoluted and confusing tax sophistry. Clearly, there are abuses and they must be dealt with effectively. However, we have a complex tax system and believe that taxpayers should be entitled to structure transactions to take advantage of intended incentives and to pay no more tax than is required by the law. Drawing this delicate balance is at the heart of the issue we are addressing today. (Italics in original.)

Clearly this is a call to determine the “spirit of the law”, by referring to the “intended incentives” that the legislature has provided. But to abuse the law by seeking out loopholes, eventually undermines the essential system of taxation.

It is imperative to strike a balance in distinguishing between those individual accountants or accounting firms taking advantage of intended incentives and those abusing loopholes to take advantage of the system itself. Such operation may be legal, but it is hardly ethical. It may strictly comply with the law, but for an organization like the government to run efficiently, more than minimal compliance is required.

Let’s call this the Lifson Principle, and see what implications it has for accountants and their clients. “Taxpayers should be entitled to structure transactions to take advantage of intended incentives and to pay no more tax than is required by the law.” The presence of the word “should” and the word “entitled” in the principle clearly make it an ethical principle. According to the principle, taxpayers have the ethical right to take advantage of intended incentives, and one could add that their accountants or accounting firms would be remiss in their responsibility to their clients if they did not take full advantage of the intended incentives. But by implication, Lifson is suggesting that there is something ethically problematic about taking account of unintended incentives, and this is precisely the kind of operation that Burger and Briloff are objecting to on the part of individual accountants and accounting firms.

As Lifson says, “We strongly oppose the undermining of our tax system by convoluted and confusing tax sophistry. Clearly, there are abuses and they must be dealt with effectively.” The tax system can be and is abused by accountants and accounting firms using tax avoidance schemes.

Implicit in all of this is a recognition of the responsibility of the accountant and firms to uphold the soundness of our tax system – to draw the delicate balance between intended tax advantages and loopholes which undermine the system.

But we have a cultural problem. Will such an interpretation of the responsibility of tax preparers fly? If you hire a tax accountant, what sort do you want, one who finds the loopholes or one who having found them tries to convince you it would be ethically unwarranted to take advantage of them? No one likes taxes, yet if no one pays taxes government cannot operate.

The Treasury Department, the ABA [American Bar Association] and others say shelters cause harm far beyond the initial loss of revenue. When one firm uses a shelter successfully, its competitors will feel pressure to try it, too, or be left at a disadvantage.

In addition, individual taxpayers, who have to pay more as others succeed in paying less, become contemptuous of the tax system and more inclined to try tax avoidance maneuvers of their own. “If unabated, this will have long‐term consequences to our voluntary tax system far more important than the revenue losses we currently are experiencing in the corporate tax base.”¹⁴

Obviously what is needed in the popular culture is a sea change in attitude, where the ethical responsibility to support the legitimate purposes of government overrides the individual interest of paying as little support as possible, even less than one’s “fair share”. Accountants and accounting firms need to recognize their responsibility to the society at large, even where this might be at the expense of their client. But of course this will probably damage them in the competitive race for clients. Who will pay for an accountant who up front indicates they may not take all the deductions “you can get away with?”

To think this would be voluntarily practiced is naïve in the extreme. If it were we would need no sanctions by the IRS to compel compliance with the tax code, not to mention the spirit of the tax code. Treasury Department Circular 230 would never need to be established. Nevertheless, absent the threat of the IRS one could argue that the accountant has an ethical obligation to temper his aggressive tax scheming on behalf of his client for the sake of the general welfare.

But why would a client, who is solely self‐interested, hire an accountant or firm who he knew would not save him every penny possible? Such a client would not. I want my tax accountant to save me as much money as possible. Nevertheless, there are people who put a constraint on that imperative … as long as it is no more nor less than my fair share. If we assume the client shares the same ethical values as the accountant or the firm there will be a happy marriage of honorable people not taking unfair advantage.

Perhaps the way to convince skeptics that such a constraint is necessary is to imagine what would happen if waste disposal firms operated in the same solely self‐interested way? I will dispose of your industrial waste in the cheapest way possible, even if it means harming the environment, as long as it is within the letter, but not the spirit, of the law. The quest for profit forces all sorts of ethical shortcuts, but if such harming is not acceptable for waste disposal firms, why is it acceptable for accounting firms to harm people by taking their money?

Clearly accountants and their companies need to insist, because of their professionalism, on following the ethical path. In an interesting article “The Tax Adviser”, Yetmar, Cooper, and Frank, address two questions.¹⁵ What helps tax advisers be ethical and what challenges their ethics?

The leading helps are personal moral values and standards plus a culture in the firm which does not encourage compromising ethical values to achieve organizational goals – a strong management philosophy that emphasizes ethical conduct and clear communication that such ethical behavior is expected. In the situations described above even in the face of a loss of a client, the accountant would do what’s right. The threat of losing one’s license for unethical conduct is a factor, but it is not ranked as the primary factor.

As to what challenges ethical conduct, the following were mentioned high on the list: the complexity and constantly changing nature of the tax laws; scarcity of time to practice due diligence; keeping current with increasingly complex tax laws; pressure from clients to reduce their tax liability; and client’s lack of understanding regarding accountants’ professional responsibilities and potential penalties for both the tax practitioner and the taxpayer. So complex tax laws and unethical demands of clients are some of the biggest potential challenges to ethical behavior on the part of tax accountants.

The authors conclude their study by stating the following:

First, business can encourage ethical behavior by refraining from pressuring managers and employees to compromise their personal values. Second, businesses should ensure that managers are equipped not only to deal with their own ethical dilemmas, but also those encountered by their subordinates. Professional associations have an opportunity to help prepare their members holding managerial positions in business to meet these responsibilities.¹⁵

But why if the government makes the tax laws can’t they plug the loopholes? Why should it be the responsibility of the accountants and accounting firms? What is their role to be in this tax crisis? The suggestion would be to take the standards seriously and review the policy of profit by any means legally possible. A great deal would be accomplished if there was voluntary compliance with the spirit of the law by the larger accounting firms. Nevertheless there will be a great deal of pressure exerted on accountants who consider themselves professionals and take their obligations to the public seriously to capitulate to the demands of their companies. This raises the age old problem for a professional who is an employee. Does one have a responsibility to the profession before the responsibility to the company for which one works? As small entrepreneurial practices are absorbed by larger firms, as happens not only in accounting, but in medicine, law, real estate, financial services, and elsewhere, this becomes more and more a crucial problem where the individual’s ethics are compromised by the company’s policies.

We will conclude this chapter by noting other standards that appear in the SSTS.

Discussion Questions

1. What are some of the responsibilities of the tax accountant to the public and why are these important from an ethics perspective?
2. Discuss how ethics plays into the exploitation of tax loopholes.
3. Identify and discuss the challenges associated with the ethical conduct of tax accountants.
4. Review the seven standards found in the Statements on Standards for Tax Service (SSTS) and create a chart of the inherent ethical responsibilities for both the tax accountant and their client in each statement.

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