Index 260

Acceptance, 53, 66 Accountants’ Liability, 1 Accounting Method, 144 Accumulated Earnings Tax, 220 ADA & Rehabilitation Act, 134 Additional for AGI Deductions, 160 ADEA, 133 Adjusted Basis, 197 Adjustments for AGI, 152 Affirmative Action, 135 Agency, 114 Alternative Minimum Tax (AMT), 179, 221 Alternatives to Bankruptcy, 110 Amount Realized, 196 Articles of Incorporation, 39 Assignment, 61 Attachment, 92 Auditor Common Law Liability, 7 Auditor Liability Under Federal Securities Laws, 8 Avoidance, 100 Avoiding Liability, 87, 88 Bailments, 142 Bankruptcy, 98 Breach of Contract, 63, 76 Business Combinations, 49 Business Expenses (Schedule C), 154

Business Reorganizations – Chapter 11, 107 Buyer’s Remedies, 77 C.O.D., 72 Carryover Rules, 186 Characteristics of Corporations, 37 Child Tax Credit, 177 Civil Rights Act (CRA), 132 Claims for Refunds, 189 Clean Air Act, 118 COBRA, 129 Commercial Paper, 79 Compensation for Services, 145 Comprehensive Environmental Response

Compensation and Liability Act, 121 Computing Corporate Income Tax, 214 Computing Taxable Income of Trusts & Estates, 241 Concurrent Interests, 138 Consideration, 54 Contracts, 51 Contributions, 163, 164 Contributions to Retirement Plans, 157 Conversion to S Corporation, 232 Corporate Formation, 212 Corporate Income Tax, 212 Corporate Reorganizations, 228 Corporate Termination, 227

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Corporations, 37 Cosureties, 113 Coverdell Education Savings Accounts (ESAs), 159 Credit Card Debt, 97 Credit for Aged or Disabled, 175 Credits, 174 Deductions, 216 Default by Debtor, 96 Defenses Against a Negotiable Instrument, 84 Defenses of Sureties, 112 Delegation, 61 Denial of Discharge, 106 Dependent Care Credit, 176 Dependent Exemptions, 172 Depreciable Personal Property, 193 Depreciable Real Property, 191 Depreciation, 191 Depreciation Recapture, 198 Directors & Officers, 41 Discharge, 62 Dissolution, 50 Distributable Net Income (DNI), 243 Distributions, 208 Distributions to Stockholders, 226 Dividends, 45, 148 Dividends-Received Deduction, 218 Documents of Title, 89, 90

Duties of Directors & Officers, 44 Earned Income Credit, 175 Employee Retirement Income Security Act (ERISA), 127 Employment, 122 Enforceability, 58, 67 Environmental Law, 117 Equal Pay Act, 132 Estate & Gift Tax, 245 Estates, 238 Exceptions to Discharge, 105 Excess Payroll Taxes, 182 Exemptions, 171 Express Warranties, 74 Federal Insurance Contributions Act (FICA), 126 Federal Securities Regulations, 16 Federal Unemployment Tax Act (FUTA), 128 Federal Water Pollution Control Act, 119 Filing Status, 184 Firm offer, 65 FLSA, 130 FMLA, 129 Foreign Tax Credit, 224 Formation of Contracts, 51 Formation of Partnerships, 32, 203 Formation of S Corporations, 231 Fraud, 3 Generation Skipping Tax, 252

Index 262

Gift, 254 Goods In Transit, 68 Gross Income, 215 Guaranteed Payments to Partners, 206 Half-Year Convention, 194 Holder in Due Course (HDC), 83 HOPE Credit, 177 Income Tax Return Preparers, 256 Independence, Integrity, & Objectivity, 13 Individual Income Tax, 143 Inheritance, 253 Insider Trading, 23 Interest, 147 Interest Expense, 168 Investment Securities, 91 Involuntary Filing – Chapter 7, 99 Itemized Deductions, 162 Leases, 142 Liability as a Tax Preparer, 11 Liability of Entering and Exiting Partners, 31 Liability Under 33 Act, 4, 5 Liability Under 34 Act, 5, 6 Lifetime Learning Credit, 177 Limited Liability, 48 Limited Liability Arrangements, 34 Limited Liability Companies (LLCs), 36 Limited Liability Partnerships, 35

Limited Partnerships, 34 Liquidating Distributions, 209 Medical Expenses, 165 Midmonth Convention, 192 Midquarter Convention, 194 Miscellaneous Expenses, 166 Moving Expenses, 153 National Labor Relations Act (NLRA), 131 Negligence, 1 Negotiable Instruments, 79 Noise Control Act, 120 Nonliquidating Distributions, 208 Obligations of Common Carriers, 70 Occupational Safety & Health Act (OSHA), 123 Offer, 52 Order of Distribution, 102 Other Income, 150 Other Itemized Deductions, 164 Other Rights of Shareholders, 46 Parent-Subsidiary Transactions, 229 Parol Evidence Rule, 59 Partner’s Basis, 207 Partners’ Authority, 29 Partners’ Liability, 30 Partners’ Property Rights, 28 Partners’ Rights, 27 Partnership, 27

Index 263

Partnership Characteristics, 27 Partnership Dissolution, 32, 33 Partnership Taxation, 203 Penalties for Late Payment, 183 Perfection, 93 Personal defenses, 85 Personal Exemptions, 171 Personal Holding Company (PHC) Tax, 219 Personal Property, 136, 139 Powers of Bankruptcy Trustee, 100 Powers of the Board of Directors, 42 Primary Liability, 86 Priorities Among Claims, 94, 95 Priority Claims, 103 Private Securities Litigation Reform Act of 1995, 9, 10 Prizes & Awards, 146 Product Liability, 75 Promoters, 40 Property, 136 Property Dispositions, 196 Property Received by Inheritance or Gift, 253 Proxies, 23 Real Defenses, 84 Real Property, 137 Realized Gain or Loss, 196 Rejection, 53 Related-Party Sales, 200

Rent & Royalty Expenses (Schedule E), 155, 156 Repayment Plans – Chapter 13, 109 Reporting, 22 Requirements for Combinations, 49 Requirements for Negotiability, 80 Rights & Obligations, 60 Rights of Directors, 41 Rights of Officers, 43 Rights of Sureties, 112 Risk of Loss, 69 Roth IRAs, 158 S Corporation Earnings, 234 S Corporations, 38, 231 Sale of Partnership Interest, 210 Sale on Approval, 71 Sale or Return, 72 Sales, 65 Sarbanes-Oxley Act of 2002, 24, 25 Schedule M-1, 225 Schedule M-2, 225 Secondary Liability, 86 Section 1244 Stock, 230 Secured Creditors, 102 Secured Transactions, 92 Securities Act of 1933, 16 Securities Exchange Act of 1934, 21 Securities Exempt from Registration, 18

Index 264

Self-Employment Tax, 178 Seller’s Remedies, 76 Seller’s Warranties, 73 Shareholder’s Basis, 236 Shareholders, 45 Special Transactions, 201 Standard Deduction, 161 Standards for Consulting Services, 14 Standards for Tax Practice, 15 Statutes of Limitations, 190 Summary of Auditor Liability, 6 Superfund, 121 Suretyship, 111 Tax Payments, 182 Tax Preparer Penalties, 258, 259 Tax Return Due Dates, 255 Tax Return Schedules, 187 Tax Year, 204 Taxable Estate, 248 Taxable Gifts, 246 Taxation of Beneficiaries, 243 Taxation of Estates & Trusts, 238 Taxation of Gains & Losses, 199 Taxation of Partnerships, 205 Taxation of S Corporations, 233 Taxation of Trusts, 240

Taxes, 169 Terminating Agent’s Authority, 116 Termination of S Corporation Status, 237 Theft or Casualty Losses, 170 Title, 68, 69 Transactions Exempt from Registration, 19, 20 Transfers of Negotiable Instruments, 81 Trust Operations, 239 Trusts, 238 Types of Agency, 114 Types of Endorsements, 82 Types of Sureties, 111 Unified Credit, 251 Unions & Collective Bargaining, 131 Unsecured Creditors, 104 Validity, 56, 57 Validity & Enforceability, 55 Voidable Preferences, 101 Voluntary Filing – Chapter 7, 98 Warranty of Fitness, 74 Warranty of Merchantability, 73 Warranty of Title, 73 When to File, 189 Who Must File, 188 Workers’ Compensation, 124

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Professional and Legal Responsibilities – Module 23

1

Accountants’ Liability

Liability under Common Law

An accountant may be liable under common law due to negligence or fraud.

Negligence

A loss due to negligence occurs when an accountant violates the duty to perform professional services in a competent manner. NEGligence may consist of

• Nondisclosure of information to a client • Errors previously discovered not being corrected • GAAP not being followed

Best defense to common law negligence is that appropriate professional standards were followed.

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Professional and Legal Responsibilities – Module 23

2

Negligence (continued)

Simple negligence

• Careless mistakes • Defense of lack of privity may be available

• But client and intended third beneficiaries have privity • Foreseen third parties have privity in majority of states under tort law • Foreseen third parties lack privity in states conforming to Ultramares case

Gross negligence

• Reckless disregard for the truth • Lack of privity not valid as defense

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Professional and Legal Responsibilities – Module 23

3

Fraud

Fraud refers to conduct that involves all of the following:

• Material false representation of fact • Justifiable reliance on the information • Awareness of the false information by the accountant • The falsity was made with the ultimate intent to deceive • The party must have suffered damages

Scienter refers to the accountant’s knowledge of a false representation or material omission of fact with the intent to deceive.

Potential defenses against fraud include

• Lack of intent to deceive • Immateriality

Lack of privity is not a valid defense

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Professional and Legal Responsibilities – Module 23

4

Liability under Federal Securities Regulations

Auditors are liable under both the Securities Act of 1933 (33 Act) and the Securities Exchange Act of 1934 (34 Act).

Liability under 33 Act

Accountants are liable under Section 11 of the 33 Act

• Liable if financial statements contain untrue statement or material omission • Liable to anyone acquiring security without knowledge of error

To be successful, the plaintiff need not prove

• Privity • Scienter • Reliance

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Professional and Legal Responsibilities – Module 23

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Liability under 33 Act (continued)

Defenses the accountant may use include

• Plaintiff’s knowledge of the error • Due diligence in performance of services

Liability under 34 Act

Accountants are liable under Rule 10b-5 of the 34 Act

• Liable for oral or written misrepresentations of fact • Liable for wrongful act committed through mail, interstate commerce, or a national

securities exchange

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Professional and Legal Responsibilities – Module 23

6

Liability under 34 Act (continued)

To be successful, the plaintiff must prove

• Scienter • Reliance

Defenses the accountant may use include

• Plaintiff’s knowledge of the error • Lack of reliance by plaintiff

Summary of Auditor Liability

Elements in action taken against an accountant 1) There is a misstatement or omission of a material fact 2) Plaintiff has reasonably relied upon the information 3) Plaintiff suffered a loss 4) Accountant was in error

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Professional and Legal Responsibilities – Module 23

7

Auditor Common Law Liability

Gross Negligence Contracts Negligence or Fraud

Who may Client or an Client or (usually) Anyone bring action intended user foreseen user injured

Accountant’s error Breach of Recklessness or resulting in action contract Carelessness intentional mis- conduct (scienter)

Plaintiff must All 4 All 4 All 4 prove elements elements elements

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Professional and Legal Responsibilities – Module 23

8

Auditor Liability under Federal Securities Laws

1933 Act 1934 Act Section 11 Rule 10b-5

Who may Any Any bring action purchaser purchaser

Accountant’s error Lack of Recklessness or resulting in action due diligence intentional mis- conduct (scienter)

Plaintiff must Elements All 4 prove 1 & 3 only Elements

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Professional and Legal Responsibilities – Module 23

9

Private Securities Litigation Reform Act of 1995

Requires auditor of publicly held company to include specific substantive procedures designed to

• Identify illegal acts, including management fraud, having a direct and material effect on the financial statements

• Identify significant related-party transactions • Determine if there is substantial doubt related to the entity’s ability to continue as a going

concern

Illegal acts must be reported to management and board of directors must be notified Board of directors must

• Notify the SEC within 1 business day • Provide auditor with copy of report to SEC

If auditor not notified • Resign from engagement • Notify SEC within 1 business day of board’s failure to meet deadline

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Private Securities Litigation Reform Act of 1995 (continued)

Responsibilities under the Sarbanes-Oxley Act • CPAs and CPA firms may be criminally prosecuted for destroying or falsifying records • Created the Public Company Accounting Oversight Board (PCAOB)

• Registers CPA firms that audit public (issuer) companies • Sets standards on auditing, quality control, independence for registered CPA firms • Restricts the types of services that a CPA firm may perform for an issuer audit client • Requires rotation of audit partner every 5 years • Requires audits of internal control over financial reporting

• Public companies must disclose whether they have adopted code of ethics for company’s officers

• For audit committees of the board of directors

• All members must be independent • Must have at least one financial expert

• Requires the CEO and CFO to certify to company’s financial statements

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Professional and Legal Responsibilities – Module 23

11

Liability as a Tax Preparer

Penalties

Actions by an accountant preparing a client’s tax return can result in penalties

• Not providing client with copy of return • Failing to sign return as a preparer • Endorsing & cashing client’s refund check

Liability to Client

Other actions may create a liability to a tax client

• Failing to file a return timely • Not advising client of tax elections • Neglecting evaluation of joint versus separate returns

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Professional and Legal Responsibilities – Module 23

12

Regulation of Accountants

• State boards of accountancy issue licenses to practice in a state

• Investigate violations of professional standards and ethics • May revoke license to practice

• AICPA and state societies of CPAs

• Investigate violations of professional ethics through Joint Ethics Enforcement Program (JEEP)

• May admonish, sanction, suspend, or expel a member

• The Securities Exchange Commission

• Investigates CPAs and CPA firms that violate SEC rules • May disbar an accountant or firm from auditing public (issuer) companies

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Regulation of Accountants (continued)

• The Public Company Accounting Oversight Board (PCAOB)

• Registers and performs inspections of firms that audit public (issuer) companies • Firms that audit more than 100 issuers are inspected every year • Firms that audit 100 or less issuers are inspected every three years • For substandard performance the PCAOB may:

• Prescribe remedial actions such as improvements in quality control • Suspend an individual or firm from auditing issuers

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Professional and Legal Responsibilities – Module 23

14

Standards for Consulting Services

When performing consulting services, a CPA must adhere to certain general standards

• Professional competence • Due professional care • Planning & supervision • Obtaining sufficient relevant data

Specific standards related to consulting services include

• Serving the client • Establishing an understanding with the client as to the nature, scope, & limitation of

services • Communicate with the client about conflicts of interest, scope of services, or benefits to

be derived

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Professional and Legal Responsibilities – Module 23

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Standards for Tax Practice

A CPA performing tax services

• May not recommend a tax position that lacks merit • Must make a reasonable effort to answer applicable questions on the return • May rely on client information when preparing the return • Must make reasonable inquiries about questionable or incomplete information • May use estimates

Contents

Preface v About the Author vii Professional and Legal Responsibilities 1 Federal Securities Acts 16 Business Structure 27 Contracts 51 Sales 65 Commercial Paper 79 Secured Transactions 92 Bankruptcy 98 Debtor-Creditor Relationships 111 Agency 114 Regulation of Business Employment, Environment, and Antitrust 117 Property 136 Individual Taxation 143 Transactions in Property 196 Partnership Taxation 203 Corporate Taxation 212 Other Taxation Topics 238 Index 260

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