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Getting to the Bottom Line about Contingent Fees

"Intaxication: Euphoria at getting a refund from the IRS, which lasts until you realize it was your money to start with." Unknown, from a Washington Post word contest

Court-judgementWhen is a CPA practice not "practice before the Internal Revenue Service?" And if it is not practice before the IRS,  does that mean it’s okay to use contingent fees in a client arrangement?

Why do I write about this topic now?  This past July, the U.S. District Court for the District of Columbia issued an opinion (Ridgely v. Lew) that takes a significant strike at IRS’s ability to regulate contingent fee arrangements. 

Gerald Ridgely is a CPA who practices with Ryan LLC, a global tax services company, but not a registered CPA firm. Ridgely sued the IRS, arguing that the Service exceeded its authority under Circular 230 in regulating the preparation and filing of ordinary refund claims, which practitioners file after a taxpayer has filed his original tax return but before the IRS has initiated an audit of the return.  Ridgely contended that the inability to charge a contingent fee for a refund claim cost him clients and significant revenue. Under a contingent fee arrangement, the client only pays the fee (or a percentage of the refund) if the claim is successful.

Prior to 2007, Circular 230 had a contingent fee rule that was very similar to the AICPA rule. IRS concerns over taxpayers playing the “audit lottery” led it to further restrict its contingent fee rule. Here’s what Circular 230 Section 10.27 says about contingent fees:
“A practitioner may not charge a contingent fee for services rendered in connection with any matter before the IRS except:
(1)   In connection with the Service’s examination of, or challenge to –
(a)    An original tax return; or
(b)   An amended return or claim for refund or credit where the amended return or claim for refund or credit was filed within 120 days of the taxpayer receiving a written notice of the examination of, or a written challenge to the original tax return.
(2) A claim for credit or refund filed solely in connection with the determination of statutory interest or penalties assessed by the IRS.
(3) For services rendered in connection with any judicial proceeding relating to the Internal Revenue Code.”

The District Court ruled in Ridgely that Circular 230 could only regulate “practice” before the IRS and the preparation of an “ordinary refund claim” was not practice. Specifically, the court focused on the text of Circular 230’s authorizing statute which uses the term “representative,” reasoning that the preparation of an ordinary refund claim before the practitioner became a representative was not practice before the IRS.  The court rejected the IRS’s argument that it had authority to regulate Ridgely on the basis of his CPA status alone, finding that a CPA preparing and filing ordinary refund claims before possessing any power of attorney possesses no legal authority to act on behalf of taxpayers and, therefore, is not a “representative” before the IRS.

The court’s order enjoining the IRS from enforcing section 10.27 is limited to those instances where the preparation and filing of the ordinary refund claim precedes the start of any examination or adjudication of the refund claim by the IRS and any formal legal representation on the part of the practitioner.  CPAs should be aware: Karen Hawkins, director of the IRS Office of Professional Responsibility, has stated that she will be looking for the narrowest interpretation of the case and the broadest interpretation of OPR’s jurisdiction.

The AICPA’s contingent fee rule, Rule 302, is a little more liberal.  Under the AICPA rule, a member could potentially charge a contingent fee for an amended return if the member can demonstrate a reasonable expectation, of “substantive consideration” by a taxing authority.  For example, the subject of the amendment is part of a test case (involving a different taxpayer) and it is likely that the taxing authority will substantively review the refund claim and not merely process the return.

Time for the questions!

  • Did the District Court rule correctly? (FYI, the IRS did not appeal.) 
  • Was the Court’s ruling fair? The Court mentions that not all preparers’ practice is regulated by Circular 230.
  • Is the court’s ruling consistent with the AICPA rule?  Remember, there has to be an expectation of substantive consideration of the claim.
  • In the wake of this case, is there a need for clarity around the current application of Circular 230, Section 10.27? 
  • Do you believe the Ridgley decision disadvantages CPAs?
  • Do you even use contingent fee arrangements?

And if “intaxication” involves getting your own money back, what do you call it when you have to give a percentage of it away? I’ll answer these questions and more in a follow-up blog post.

Edward S. Karl, CPA, Vice President of Taxation, American Institute of CPAs.

Court judgement image via Shutterstock

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