CPA or Loan Preparer Made Errors: Am I Still Liable?

CPA or Loan Preparer Made Errors: Am I Still Liable?

The signature on the return is yours. The liability, under federal law, follows the signature, not the hand that prepared the document. This is the answer most people do not wish to receive, and it is the answer that governs every conversation that follows: when a CPA or loan preparer introduces an error into your tax return or loan application, the government’s first inquiry is not who caused the mistake. The inquiry is who certified the document as accurate.

Under penalties of perjury, the taxpayer affirms that the contents of the return are true, correct, and complete. The Internal Revenue Service treats that affirmation as dispositive. Your CPA may have transposed a figure, omitted a Form 1099, or misapplied a provision of the Code. The tax you owe remains yours.

The Distinction Between Tax Owed and Penalties Assessed

One must separate the obligation from the consequence. The underlying tax, the amount that represents what you should have paid absent any error, belongs to you regardless of who prepared the return. No delegation of preparation alters that fact. If your CPA understated your income by misclassifying a distribution, you owe the difference. There is no mechanism in the Code that transfers this primary obligation to the preparer.

Penalties occupy different terrain.

Section 6662(a) of the Internal Revenue Code imposes an accuracy-related penalty of twenty percent on any underpayment attributable to negligence or a substantial understatement of income tax. Section 6664(c)(1) provides an exception: the penalty does not apply where the taxpayer acted with reasonable cause and in good faith. This is where the preparer’s error becomes relevant, if it becomes relevant at all. The distinction matters because many taxpayers conflate the two categories, assuming that a preparer’s mistake absolves them entirely. It may, under the right conditions, absolve them of the penalty. The tax itself is a separate arithmetic.

And the conditions are not generous. The Tax Court’s decision in Neonatology Associates, P.A. v. Commissioner, affirmed by the Third Circuit in 2002, established a three-pronged test that continues to govern the reasonable reliance defense. One must demonstrate that the adviser possessed sufficient competence and expertise to justify reliance. One must prove that accurate and complete information was furnished to the adviser. One must establish that the reliance was in good faith. All three prongs must be satisfied. Most claims fail at the third.

Good faith reliance does not mean handing a shoebox of receipts to a CPA and signing whatever comes back. It means reviewing the return. It means asking questions about items that appear unfamiliar or results that appear too favorable. The Tax Court has noted in cases following Neonatology that unconditional reliance, without the exercise of ordinary prudence, is insufficient. A taxpayer who signs a return showing zero liability on substantial income cannot claim good faith simply because a professional prepared it.

I am less certain about how courts outside the Third Circuit apply the second prong, which concerns the completeness of information provided. The case law varies, and the taxpayer’s sophistication weighs differently depending on the jurisdiction and the judge.

Loan Applications and Federal Exposure

For loan preparers, the stakes change in character. A tax return error produces civil liability and, in extreme cases, a referral to Criminal Investigation. A loan application error can produce federal charges under statutes that carry sentences measured in decades, not months.

Section 1014 of Title 18 makes it a crime to present false statements to a federally insured bank. Section 1344 addresses bank fraud. The mortgage application, the Uniform Residential Loan Application, carries its own certification: the borrower attests that the information provided is true and correct. When a loan preparer inflates your income, fabricates employment history, or misrepresents the intended use of the property, the federal government has the authority to charge you, the borrower, with fraud. The document bears your name.

The defense available to you is the absence of intent. The government must prove that you knowingly made false statements. A loan officer who altered figures without your knowledge is the loan officer’s problem. But the government will ask why you failed to notice that your stated income on the application was double your actual salary. The certification you signed, the one printed in bold above the signature line on the HUD-1, warns that false statements constitute a crime under Title 18.

A loan officer can tell you what you qualify for. That does not mean the numbers on the application reflect what you earn.

In something like forty of the mortgage fraud cases our office has reviewed over the past several years, the borrower’s primary defense was that the loan officer filled in the figures. The defense performed unevenly. Where borrowers could demonstrate they had provided accurate financial documents and that the loan officer altered them, the defense held. Where borrowers signed applications containing figures they should have recognized as false, it did not.

The Neonatology Framework in Practice

The three prongs of the Neonatology test deserve scrutiny, because each one fails for a different category of reason.

On the question of adviser competence: a CPA with an active license and relevant experience will generally satisfy this requirement. A friend who prepares returns as a side occupation will not. The Tax Court in CNT Investors, LLC v. Commissioner held that a long-term relationship with a lawyer who lacked specific tax expertise could satisfy this prong, but that outcome turned on the taxpayer’s own unfamiliarity with tax concepts. The sophistication of the taxpayer cuts against reliance. The more one understands about taxation, the more the court expects one to scrutinize what the adviser produces.

In January of 2000, when the Tax Court issued its opinion in Neonatology, the landscape of tax preparation was different. Fewer non-credentialed preparers operated in the market. The question of competence was simpler to resolve. Today, any person with a Preparer Tax Identification Number can prepare returns for compensation. The Government Accountability Office has reported that returns prepared by non-credentialed preparers carry a higher estimated rate of errors than self-prepared returns. Whether your preparer held any credential beyond a PTIN is a question you should be prepared to answer.

The second prong, concerning the information provided, is where cases fracture most often. In Perry, the taxpayer reported only half of her retirement distributions and claimed reliance on her advisers. The Tax Court sustained the penalty, finding she had failed to prove that her advisers were sufficiently knowledgeable or that she had furnished them with complete information. If you withhold a document, forget to mention a source of income, or provide records that are incomplete, the reliance defense disintegrates. The preparer cannot be blamed for errors arising from information the preparer never received.

Good faith, the final prong, requires something more than passive trust. The regulations contemplate a taxpayer who reviews the return, identifies items that appear incorrect, and raises questions. Warning signs that should have prompted scrutiny include a refund that appears too large, a tax liability of zero despite significant income, deductions the taxpayer cannot explain, and credits for dependents who do not reside in the household.

Three cases in the past two years alone have turned on whether the taxpayer reviewed the completed return before signing.

Criminal Referral

The line between a civil penalty and a criminal referral is a single word. Under Section 7201, tax evasion requires willfulness, which the Supreme Court in Cheek v. United States defined as the voluntary, intentional violation of a known legal duty. A preparer’s error, standing alone, does not create criminal liability for the taxpayer. The error must be accompanied by the taxpayer’s awareness that the return was wrong.

When an IRS Criminal Investigation agent contacts you rather than a revenue agent, the posture of the case has changed. CI agents are law enforcement. Their objective is prosecution, not collection. The distinction between the two, if we are being precise, is not merely procedural; it determines whether the outcome is a payment plan or a sentencing hearing.

Whether the Cheek framework applies with the same force to preparer-error cases as it does to the protest cases that generated it is a question worth considering. The case law has not produced a clean answer.

Civil Recovery and Practical Steps

The government comes to you first. This describes enforcement economics, not philosophy. Collecting from the taxpayer is procedurally straightforward: the IRS can levy bank accounts, garnish wages, file liens against property. Pursuing the preparer requires a separate investigation, often a referral to the Department of Justice, and litigation that can extend for years. You are, in the government’s calculation, the path of least resistance.

Civil recourse against the preparer exists as a separate matter, and it is worth pursuing where the facts support it. A CPA who fails to meet the applicable standard of care may be liable in negligence or for breach of contract. The damages recoverable in a malpractice action typically include penalties and interest attributable to the error. Some courts have reasoned that interest is not recoverable, on the theory that the taxpayer had use of the unpaid funds during the period of the underpayment and therefore suffered no economic harm from the delay. The underlying tax, the amount you owed regardless of the error, is generally not a compensable damage.

Before pursuing a claim, review the engagement letter. Most engagement agreements allocate responsibility for the accuracy of underlying data to the client and restrict the preparer’s liability to the fees paid. Whether such limitations are enforceable depends on the jurisdiction. In New York, consumer arbitration clauses may be voidable under General Obligations Law Section 5-327, a provision that merits examination before concluding that the engagement letter forecloses all recourse.

The steps one should take are these. First, file an amended return correcting the error; the longer an inaccuracy sits uncorrected, the worse the consequences become. Second, request penalty abatement from the IRS, citing reasonable reliance on a tax professional and providing documentation of the adviser’s credentials, the information you supplied, and any communications reflecting your reliance. Third, and this is the step most people neglect, consult with a tax attorney before responding to any IRS correspondence, particularly if the communication comes from Criminal Investigation rather than a revenue agent.

A consultation with our firm costs nothing and assumes nothing. It is the beginning of a diagnosis.

There is a cruelty in the architecture of preparer liability that the Code does not acknowledge and that no procedural reform appears likely to address. You paid for expertise. The expertise failed. And the system, designed above all to collect revenue, has little procedural incentive to distinguish your situation from that of a taxpayer who fabricated the numbers personally. The distinction exists in the statute. It does not always exist in enforcement. What a taxpayer can do, before the error compounds, before the penalty accrues, before the CI agent appears at the door of a conference room on a Tuesday morning, is act with the kind of diligence the law assumes you possessed from the beginning.