Latest / VoraPrep Audio — Professional Licensure & Certification Exam Prep / [EA] SEE3: Circular 230: Client Records, Requests, and Practitioner Duties
Transcript
- Hey, welcome to VoraPrep Audio. Alright, so let's talk about one of those situations that every single tax practitioner hopes they never have to deal with, but probably will. It's that phone call. The one where a client fires you, right in the middle of an engagement. And they want *everything* back. Now. And to make it worse, they haven't paid their full bill. So what do you do? What are you legally, ethically required to hand over, and what can you actually keep? This isn't just a business dispute; one wrong move, like holding their original W-2s hostage because you're owed money, could land you in hot water with the IRS Office of Professional Responsibility. So knowing these rules cold is absolutely critical. The core of this is in Circular 230, specifically section 10.28. And the rule is simple and non-negotiable. Upon a client's request, you have to promptly return any and all records of the client. The whole game is figuring out what, exactly, counts as "records of the client." Think of it like a coat check at a restaurant. You give them your coat, they give you a ticket. When you come back with the ticket, they give you your coat back. It doesn't matter if you had a terrible meal or you got in an argument with the manager about the bill. That's still your coat. You get it back. Period. Client records are the same way. They are the client's property that you are just holding. This means all the documents and data they gave you — W-2s, 1099s, those brokerage statements, a shoebox full of receipts, even their prior-year tax returns that someone else prepared. It's their stuff. You have to return it. What it does *not* include is your own work product. That's the stuff *you* created. The tax return you were preparing, even if it's just a draft. Your internal worksheets, your schedules, your analysis. That's not their coat. That's the service you were providing, and you can generally hold onto that if you haven't been paid. So on the exam, every single one of these questions boils down to a pretty straightforward decision process. First thing you do, you look at the list of documents in the question and you sort them into two piles, mentally. Pile one is stuff the client gave you. Pile two is stuff you created. That distinction is everything. For everything in pile one—the client's stuff—the rule is absolute. You must return it. Promptly. It doesn't matter if they owe you money. It doesn't matter if you think they're being unfair. Circular 230 says you give it back. Now, for pile two—your work product—the rule is conditional. You can usually withhold those records if you're owed a fee. The only catch is if some state law says you can't, but the exam is testing federal rules. So unless they specifically tell you a state law applies, you can assume you're allowed to keep your draft return until you get paid. This is where you'll see the classic trap on the exam. An answer choice will say you can hold all the client's documents until the fee is paid. That is a direct violation of Circular 230. A quick mental check is to ask: is this document something the client needs to file their taxes or deal with other obligations? If it's their W-2, of course they do. So you have to return it. And this all connects to another duty in Circular 230, which is that you can't unreasonably delay any matter before the IRS. Holding onto a client's records is a classic way to cause a delay, and the IRS doesn't like that. Okay, so while you're returning the client's originals, you have your own record-keeping duties. Under the Internal Revenue Code, you have to keep certain records for three years. You have two options here. You can either keep a copy of the actual completed return you prepared for every client. Or, you can keep a list. And that list has to have the taxpayer's name, their Taxpayer ID Number, the tax year, and the type of return you prepared. One or the other, for three years. And this diligence extends beyond just the 1040. Let's say you're preparing information returns for a business client, like Form 1099s. Your client is the one responsible for the numbers, sure. But your duty under Circular 230 is to not ignore something that looks obviously wrong. If the client gives you information that seems incomplete or just… weird, you have a duty to make reasonable inquiries. You can't just blindly type it in. Here’s a little memory aid that might help you keep the main rule straight. Just think CPR. Client's Property Returns! It’s a simple way to remember that the client's original property must be returned, no matter what. You can’t hold it hostage. Let's walk through a quick example, just like you'd see on the exam. David is an Enrolled Agent. He was hired by Maria to do her tax return. She paid him a $500 retainer, but the final bill is $1,200. David finishes a draft of the return, but Maria isn't happy with the fee and terminates the engagement. She sends an email demanding everything back: her W-2, her 1099s, a spreadsheet of deductions she made, and a copy of the tax return David prepared. So what does David have to do? First, let's sort the pile. The W-2, the 1099s, and her spreadsheet of deductions? Maria provided those. They are "records of the client." They're her property. Next, what did David create? He created the draft Form 1040. That's his work product. So, applying the rules. David must immediately give Maria back her W-2, her 1099s, and her spreadsheet. He cannot, under any circumstances, hold those documents waiting for the other $700. But the draft return he prepared? That's his work product. He is allowed to withhold that until his fee is paid, as long as there's no state law preventing it. So the correct answer would be that he must return her original documents, but he can withhold the draft return. If you were tempted to pick an answer saying David can keep everything until he gets paid, you've fallen for the trap. A lot of people think they have a lien on everything related to the work, but Circular 230 is very specific. Your lien doesn't apply to the client's personal property. A common point of confusion here is mixing up state accountancy board rules with federal Circular 230 rules. Your state might have certain rules about liens, but for practice before the IRS, Circular 230 is the supreme law of the land. It preempts any state rule that would let you hold a client's W-2 hostage. So on exam day, just keep your focus on ownership. If the client owned it before they walked in your door, you have to give it back. If you created it, it's yours to control, pending payment. The IRS just wants to make sure taxpayers aren't blocked from meeting their obligations because of a fee dispute with their preparer. So, boiling it down: you have to return a client's original records, no matter what. You can usually keep your own work product if you're owed money. And you personally need to keep copies of returns or a detailed list for at least three years. If you want to practice questions just like this, and trust me, you will see this tested, check out the VoraPrep app. It's a full exam-prep course with lessons, thousands of practice questions, and an AI tutor to help you work through these scenarios. You can get started at Vora Prep dot com. Alright, that's it for today. You're doing the hard work, and it will pay off. Keep up the great work. I'll talk to you on the next one.