Preparers Warned to be Vigilant About Documenting Loans

Author Kristen A Parillo

Originally Published May 27, 2019 by Tax Notes

Based on the information in this article and the sources for the article, please discuss any related party loans that you may have between your entities and the owners.  Proper documentation, interest and payment plans need to be in place.

Tax return preparers can stay out of the crosshairs of a criminal tax evasion investigation by insisting that clients document loans they want to take from their businesses, according to a Justice Department prosecutor.

Proper documentation “will save you a lot of headaches in the long run if your client is someone who ultimately is subject to investigation and prosecution,” said Christopher W Schmeisser, an assistant U.S. attorney based in New Haven, Connecticut.  “You will very frequently be pulled into it, even if you aren’t ultimately charged – and it will not be pleasant.” 

At a May 16 criminal tax conference at Quinnipiac University School of Law in North Haven, Connecticut, Schmeisser said one of his pet peeves in prosecuting tax cases is seeing return preparers fail to follow their due diligence obligations when dealing with unscrupulous clients.

A favorite tax avoidance tactic of some small business owners is to classify transfers of income to the owner as loans, Schmeisser said.  “It’s appropriate in certain circumstances for an owner to take loans out of a company that he or she has started,” he said.  “But that is not a license to use that as a way to completely pay out all kinds of income that the entity is actually generating.”

Schmeisser said that in some of the cases he has handled, “there’s just no effort by the preparer to actually do any of the appropriate paperwork.”

“Year after year, there is substantial monies coming out of entities where there is no loan documentation prepared, no actual reflection of interest accrued, no recording of any payment of interest because no interest was paid,” Schmeisser continued.  “Everything is just sort of thrown into a loan file bucket, which is pretty obviously just an effort to delay and defer the payment of taxes on income.”

For the preparer, becoming the subject of a criminal tax investigation because of a client’s bad behavior is a grueling experience, even if the preparer isn’t ultimately charged, said Schmeisser.

“I would strongly encourage you that if you do have clients that are coming in and wanting to get loans from their businesses, make sure you follow the IRS regulations in terms of proper documentation, proper recording of interest, and proper payment of taxes on those loans,” Schmeisser said.

Amy L Hosney, special agent with the IRS Criminal Investigation office in New Haven, said she has dealt with the loan issue in several investigations.  In one case in which a business owner was siphoning millions of dollars from his two companies, the CI team went to the preparer seeking his cooperation, she said.

The business owner pleaded guilty to tax fraud, and the preparer “ended up being the main defendant in the case, went to trial, and was convicted,” Hosney said.