Case Study: Tax Shelters (Ethics)

“You are a tax manager and work for a CPA firm that performs audits, advisory services, and tax planning for wealthy clients in a large Midwestern city. You just joined the tax department after five years as a tax auditor for the county government. During the first six months in tax, you found out that the firm is aggressively promoting tax shelter products to top management officials of audit clients. Basically, the company developed a product and then looked for someone in management to sell it to, rather than the more conventional method whereby an officer might approach the firm asking it to identify ways to shelter income.
The way these products work is the firm would offer an opinion letter to the taxpayer to provide cover in case the IRS questioned the reasonableness of the transaction. The opinion would say that the firm reasonably relied on a person who is qualified to know, and that would support the contention that the opinion was not motivated out of any intention to play the audit lottery. It also would protect the taxpayer against penalties in the event the firm is not correct and does not prevail in a tax case.
As time goes on, it becomes clear that the culture of the tax department is shifting from client service to maximization of tax revenues. You become concerned when you discover the firm did not register the tax shelter products, as required under the law.
One day you are approached by the tax partner you report to and asked to participate in one of the tax shelter transactions, with the end result being you would recommend to the tax partner whether he should sign off before presenting the product to the client. You feel uncomfortable with the request based on what you have learned about these products. You make an excuse about needing to complete three engagements that are winding down and buy some time.
The first thing you do is look for completed tax shelter arrangements with clients that had been reviewed and approved by the tax quality control engagement partner. What you find makes you more suspicious about the products. Several are marked restricted on the cover page without any further details. You then call a friend who is a manager in the audit department and set up a time to meet and discuss your concerns.
What you learn only heightens your concerns. Your friend confided that there is a culture in the tax department where business rationality sometimes displaces professional norms, a process accelerated by a conformist culture. Your friend also confided that the audit managers and partners are jealous of their tax peers because the tax managers and partners earn almost twice what the auditors earn because of the higher level of client revenues. It was clear your friend harbors ill feelings about the whole situation.
The following week the tax partner comes back and presents you with another tax shelter opportunity for the firm and all but demands that you oversee it. He implies in a roundabout way that your participation is a rite of passage to partnership in the firm. You manage to stall and put off the final decision a few days.
Questions
1. Evaluate the ethics of the tax shelter transactions, including your concerns about the practices.
2. Who are the stakeholders in this case, and what are your professional responsibilities to them?
3. What are the options available to you in this matter?
4. What would you do and why?”
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